Electricity Price Forecasting A Review of The State-Of-The-Art PDF

International Journal of Forecasting 30 (2014) 10301081
Contents lists available at ScienceDirect

International Journal of Forecasting
journal homepage: www.elsevier.com/locate/ijforecast
Review
Electricity price forecasting: A review of the state-of-the-art
with a look into the future
Rafa Weron
Institute of Organization and Management, Wrocaw University of Technology, Wrocaw, Poland
a r t i c l e i n f o
Keywords:
Electricity price forecasting
Day-ahead market
Seasonality
Autoregression
Neural network
Factor model
Forecast combination
Probabilistic forecast
a b s t r a c t
A variety of methods and ideas have been tried for electricity price forecasting (EPF) over
the last 15 years, with varying degrees of success. This review article aims to explain the
complexity of available solutions, their strengths and weaknesses, and the opportunities
and threats that the forecasting tools offer or that may be encountered. The paper also
looks ahead and speculates on the directions EPF will or should take in the next decade
or so. In particular, it postulates the need for objective comparative EPF studies involving
(i) the same datasets, (ii) the same robust error evaluation procedures, and (iii) statistical
testing of the significance of one models outperformance of another.
2014 The Author. Published by Elsevier B.V. on behalf of International Institute of
Forecasters.
This is an open access article under the CC BY-NC-ND license
(http://creativecommons.org/licenses/by-nc-nd/3.0/).
Contents
1. Introduction.......................................................................................................................................................................................... 1031
2. Literature query.................................................................................................................................................................................... 1032
2.1. Bibliometrics of electricity price forecasting ....................................................................................................................... 1032
2.2. Major review and survey publications ................................................................................................................................... 1034
3. What and how are we forecasting? .................................................................................................................................................... 1036
3.1. The electricity spot price ....................................................................................................................................................... 1036
3.2. Forecasting horizons................................................................................................................................................................ 1038
3.3. Evaluating point forecasts ....................................................................................................................................................... 1038
3.4. Overview of modeling approaches ......................................................................................................................................... 1039
3.5. Multi-agent models ................................................................................................................................................................. 1040
3.5.1. Nash-Cournot framework ........................................................................................................................................ 1040
3.5.2. Supply function equilibrium.................................................................................................................................... 1040
3.5.3. Strategic production-cost models ........................................................................................................................... 1041
3.5.4. Agent-based simulation models .............................................................................................................................. 1041
3.5.5. Strengths and weaknesses ....................................................................................................................................... 1042
3.6. Fundamental models ............................................................................................................................................................... 1042
3.6.1. Parameter-rich fundamental models ...................................................................................................................... 1043
3.6.2. Parsimonious structural models.............................................................................................................................. 1043
E-mail address: rafal.weron@pwr.wroc.pl.
http://dx.doi.org/10.1016/j.ijforecast.2014.08.008
0169-2070/ 2014 The Author. Published by Elsevier B.V. on behalf of International Institute of Forecasters. This is an open access article under the CC
BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/3.0/).
R. Weron / International Journal of Forecasting 30 (2014) 10301081 1031
3.7. Reduced-form models ............................................................................................................................................................. 1044
3.7.1. Jump-diffusion models............................................................................................................................................. 1045
3.7.2. Markov regime-switching models........................................................................................................................... 1047
3.8. Statistical models..................................................................................................................................................................... 1049
3.8.1. Similar-day and exponential smoothing methods ................................................................................................. 1049
3.8.2. Regression models.................................................................................................................................................... 1050
3.8.3. AR-type time series models ..................................................................................................................................... 1051
3.8.4. ARX-type time series models................................................................................................................................... 1052
3.8.5. Threshold autoregressive models............................................................................................................................ 1054
3.8.6. Heteroskedasticity and GARCH-type models ......................................................................................................... 1055
3.9. Computational intelligence models........................................................................................................................................ 1056
3.9.1. Taxonomy of neural networks................................................................................................................................. 1057
3.9.2. Feed-forward neural networks ................................................................................................................................ 1057
3.9.3. Recurrent neural networks ...................................................................................................................................... 1059
3.9.4. Fuzzy neural networks ............................................................................................................................................. 1060
3.9.5. Support vector machines ......................................................................................................................................... 1060
4. A look into the future of electricity price forecasting ...................................................................................................................... 1061
4.1. Fundamental price drivers and input variables ..................................................................................................................... 1061
4.1.1. Modeling and forecasting the trend-seasonal components................................................................................... 1061
4.1.2. Spike forecasting and the reserve margin............................................................................................................... 1062
4.2. Beyond point forecasts ............................................................................................................................................................ 1065
4.2.1. Interval forecasts ...................................................................................................................................................... 1065
4.2.2. Density forecasts....................................................................................................................................................... 1066
4.2.3. Threshold forecasting............................................................................................................................................... 1067
4.3. Combining forecasts ................................................................................................................................................................ 1067
4.3.1. Point forecasts........................................................................................................................................................... 1068
4.3.2. Probabilistic forecasts............................................................................................................................................... 1070
4.4. Multivariate factor models...................................................................................................................................................... 1071
4.5. The need for an EPF-competition ........................................................................................................................................... 1073
4.5.1. A universal test ground ............................................................................................................................................ 1073
4.5.2. Guidelines for evaluating forecasts ......................................................................................................................... 1074
4.6. Final word................................................................................................................................................................................. 1075
Acknowledgments ............................................................................................................................................................................... 1075
References............................................................................................................................................................................................. 1075
1. Introduction
Since the early 1990s, the process of deregulation and
the introduction of competitive markets have been reshap-
ing the landscape of the traditionally monopolistic and
government-controlled power sectors. In many countries
worldwide, electricity is now traded under market rules
using spot and derivative contracts. However, electricity is
a very special commodity. It is economically non-storable,
and power system stability requires a constant balance
between production and consumption (Kaminski, 2013;
Shahidehpour, Yamin, & Li, 2002). At the same time, elec-
tricity demand depends on weather (temperature, wind
speed, precipitation, etc.) and the intensity of business and
everyday activities (on-peak vs. off-peak hours, weekdays
vs. weekends, holidays and near-holidays, etc.). On the one
hand, these unique andspecific characteristics leadto price
dynamics not observedinany other market, exhibiting sea-
sonality at the daily, weekly and annual levels, and abrupt,
short-lived and generally unanticipated price spikes. On
the other hand, they have encouraged researchers to inten-
sify their efforts in the development of better forecasting
techniques.
At the corporate level, electricity price forecasts have
become a fundamental input toenergy companies decision-
making mechanisms (Bunn, 2004; Eydeland & Wolyniec,
2003; Weron, 2006). As the California crisis of 20002001
showed, electric utilities are the most vulnerable, since
they generally cannot pass their costs on to the retail
consumers (Joskow, 2001). The costs of over-/under-
contracting and then selling/buying power in the balanc-
ing (or real-time) market are typically so high that they can
lead to huge financial losses or even bankruptcy. Extreme
price volatility, whichcanbe uptotwoorders of magnitude
higher than that of any other commodity or financial asset,
has forced market participants to hedge not only against
volume risk but also against price movements. Price fore-
casts froma fewhours to a fewmonths ahead have become
of particular interest to power portfolio managers. A gen-
erator, utility company or large industrial consumer who is
able to forecast the volatile wholesale prices with a reason-
able level of accuracy can adjust its bidding strategy and its
own production or consumption schedule in order to re-
duce the risk or maximize the profits in day-ahead trading.
A variety of methods and ideas have been tried for
electricity price forecasting (EPF), with varying degrees of
success. This review article aims to explain the complexity
of the available solutions, with a special emphasis on
the strengths and weaknesses of the individual methods.
In an attempt to determine which approaches are the
most popular, In Section 2 we provide an overview of the
1032 R. Weron / International Journal of Forecasting 30 (2014) 10301081
existing literature on EPF, including a bibliometric study
of the Web of Science and Scopus databases, and a brief
summary of the review/survey publications on this topic.
InSection3, we explainthe mechanics of price formationin
electricity markets and define the main object of interest:
the day-ahead electricity price. Next, following Weron
(2006), we classify the techniques in terms of both the
planning horizons duration and the applied methodology,
and reviewthe most interesting approaches. We look back
over the last 15 years of EPF, in an attempt to systematize
the rapidly growing literature. Then, in Section 4, we
look ahead and speculate on the directions EPF will or
should take in the next decade or so. In particular, we
propose a universal test ground that all forecasters should
use in order to allow for direct comparisons between the
different studies, stress the importance of seasonality and
fundamentals in EPF, and highlight some recent trends
interval and density forecasting, the forgotten art
of combining forecasts, and the increasing popularity of
multivariate factor models.
2. Literature query
There are essentially two ways to learn about a new
research area. One is to perform a literature query using
one of the established databases and find the hot topics,
the highly cited papers (hoping that they are the influ-
ential ones), and the publishing trends. The other is to
read a couple of review/survey papers, trusting that they
are unbiased, wide in scope and relatively up-to-date. To
help a newcomer to the field of electricity price forecast-
ing (EPF), we have performed both a bibliometric analy-
sis (Section 2.1) and a critical review of the review/survey
publications that are out there (Section 2.2).
2.1. Bibliometrics of electricity price forecasting
In this section, we report on the bibliometric analysis
we performed on 10 May 2014 using two well-established
and generally acknowledged databases: Web of Science
(WoS) and Scopus. The results do differ quantitatively, as
the collections of publications indexed by WoS and Scopus
are not the same, but do not differ qualitatively. Generally,
WoS is a subset of Scopus, meaning that we could limit our
analysis to WoS only. However, the Scopus search engine is
more user-friendly and allows for more refined queries. If
we limit our search to journal articles published in English
only, then the differences between the databases are not
that significant. We will first present general results for
both databases, then more specialized queries for Scopus
only. We should also note that the choice of these two
databases has its limitations, most notably the fact that
some of the newer journals, like the Journal of Energy
Markets, are not indexed in these systems.
In Fig. 1, we plot the numbers of WoS- and Scopus-
indexed EPF publications in the years 19892013.
1
The
overall numbers of publications are 304 for WoS and
1
To search publication titles, abstracts and keywords for electricity
price forecasting-related phrases, we have used the following WoS
497 for Scopus, of which 136 (45%) and 206 (41%),
respectively, are journal articles. Articles indexed within
the Web of Science refer to journals listed in the Journal
Citation Reports only, while the collection of Scopus-listed
journals is much richer. Both databases are constantly
being expanded to cover more volumes of proceedings, but
the numbers are still much less representative of the true
number of conference papers than is the case for journals
and journal articles. The Scopus-indexed collection of
reviews, conference reviews, books and book chapters
is even less complete. Hence, in what follows, we will
concentrate mostly on journal articles.
Except for a few isolated cases, EPF publications
did not appear in the literature before the year 2000.
The next major breakthrough occurred in the years
2005 and 2006, when the number of publications first
doubled, then tripled with respect to 20022004 figures.
Initially, this increased inflow of EPF publications was due
mostly to proceedings (WoS terminology) or conference
(Scopus terminology) papers; journal articles followed
with a delay. The overall publication rate increased until
2009/2010, thendroppedto 20062008 levels because of a
reduced number of conference papers. As of 2013, the topic
seems to have saturatedthe researchcommunity, although
the number of citations is still increasing, as can be seen
in Fig. 2. Possibly a new fundamental impulse like the
deregulation of the late 1990s or the increased volatility
of electricity spot prices in the mid-2000s is needed in
order to propel electricity price forecasting to a new level
of publication intensity.
As far as subject categories are concerned, most of the
articles have appeared in journals classified by Scopus
as Engineering or Energy, followed by Computer Science,
Mathematics, Business, Management & Accounting and
Economics, Econometrics & Finance. It is also interesting to
see which outlets are the most popular for EPF articles.
Clearly, the number one journal is IEEE Transactions
on Power Systems, with 33 publications (out of 206
indexed by Scopus), see Fig. 3. Interestingly, the share
of neural network-type (more generally: artificial or
computational intelligence) methods and statistical time
series models is equal in this collection: nine neural
network papers, nine statistical time series papers, four
papers where both approaches have been used and 11
papers where neither neural network nor statistical
time series methods have been used. It should be noted
that the classification was automatic and may include
some errors. For neural network-type papers, the Scopus
query given in footnote 1 was modified to include
query: TS=(((forecasting electricity" OR predicting
electricity") AND (electricity spot OR elec-
tricity day-ahead OR electricity price)) OR
((price forecasting OR price prediction
OR forecasting price OR predicting price
OR forecasting spikes OR forecasting VAR)
AND (electricity spot price OR electricity
price OR electricity market OR day-ahead
market OR power market))); and the equivalent Scopus
query: TITLE-ABS-KEY(...). All look-ups have been refined further to
exclude non-English language texts or to include only specific document
types.
Fig. 1. The numbers of WoS- (left panel) and Scopus-indexed (right panel) electricity price forecasting (EPF) publications in the years 19892013. All
publications prior to the year 2000 (three for WoS, three for Scopus) have been aggregated into one category, <2000.
Fig. 2. The numbers of WoS- (left panel) and Scopus-indexed (right panel) EPF journal articles and citations of those articles in the years 19892013. All
articles prior to the year 2000 (one for WoS, three for Scopus) have been aggregated into one category, <2000; i.e., the first bin. Note that the numbers of
citations are roughly 25 times higher than the numbers of articles.
Fig. 3. The numbers of Scopus-indexed EPF articles published in the years 20002013 in the ten most popular journals. Neural network-type models are
more often published in electrical engineering journals, while statistical time series models tend to be published in Energy Economics, International Journal
of Forecasting, Applied Energy and Energy Policy.
(AND neural network), and yielded 91 articles.
Adding (OR artificial intelligence) or (OR
fuzzy) increased the count by one to four articles
only; neither of these modifications was used. The look-up
for statistical time series methods is more complicated, as
there is no single most popular phrase. We used a logical
search string which included most of the commonly used
keywords or phrases in such articles.
2
The overall count
obtained is 100 articles out of the 206 indexed by Scopus.
If we consider four disjoint sets: (i) neural network
papers, (ii) statistical time series papers, (iii) papers where
both approaches were used and (iv) papers where neither
neural network nor statistical time series methods were
used, then the overall counts are 46, 55, 45 and 60,
respectively. Looking again at Fig. 3, we can conclude that
neural network-type models are published more often in
electrical engineering journals, while statistical time series
models tend to appear in Energy Economics, International
Journal of Forecasting, Applied Energy (which is somewhat
surprising, as this journal is classified by Scopus in the
Energy and Engineering subject areas) and Energy Policy.
A probable reason for the latter situation is the differ-
ence between the educational training of electrical engi-
neers andeconometricians (statisticians), whichconstitute
the twomaingroups of authors whosubmit papers tothese
two journal classes. In the late 1990s, computational in-
telligence (CI) methods and neural networks in partic-
ular were a hot topic among engineers, and engineering
faculties offered many such courses.
3
On the other hand,
the typical background of an electrical engineer educated
in the 1990s and 2000s did not include much of statis-
tics. The situation is quite the opposite among econome-
tricians and statisticians. CI classes were not (and still are
not) part of the typical curriculum. These differences in ed-
ucational training have their consequences inthe quality of
the research. Typically, electrical engineering papers con-
sider sophisticated CI tools and relatively simple (or not
properly applied) statistical models, and when the two are
compared, the former tend to performbetter. On the other
hand, econometric or statistical papers usually showthat
(advanced) statistical models outperform(simple) CI tech-
niques. In addition, given that electrical engineers typically
have no training or experience in a statistically sound val-
idation of the model performance, there is definitely room
for improvement and closer cooperation between the two
communities.
To end this section, let us comment briefly on the
most popular outlets for proceedings papers. Definitely
the number one are the numerous IEEE conferences (on
Power Engineering, Power Systems, Man & Cybernetics, and
Neural Networks). Next in line are Lecture Notes in Computer
Science, the proceedings of the European Electricity Market
(EEM) Conference and the proceedings of the Chinese
2
The Scopus query given in footnote 1 was modified to include: AND
(AR OR ARMA OR ARIMA OR GARCH OR
VAR OR time series model OR regression
OR autoregressive OR autoregression OR
volatility).
3
Thanks to Tao Hong for pointing this out.
Control and Decision Conference. The overall count of
Scopus-indexed conference papers is 274 (in the years
20002013), compared to 206 journal articles (in the years
19892013).
2.2. Major review and survey publications
The publication trends discussed in Section 2.1 suggest
that electricity price forecasting has saturated the research
community. Onthe other hand, the small numbers of books
and reviewarticles on this topic indicate that this research
area is not very mature yet. To the best of our knowledge,
there are essentially only three books which address EPF:
Shahidehpour et al. (2002, Chapter 3, pp. 57113) dis-
cuss the basics of electricity pricing and forecasting
(price formation, volatility, exogenous variables), de-
scribe a price forecasting module based on neural net-
works, and comment on performance evaluation.
Weron (2006, Chapter 4, pp. 101155) provides an
overview of modeling approaches, then concentrates
on practical applications of statistical methods for
day-ahead forecasting (ARMA-type, ARMAX, GARCH-
type, regime-switching), discusses interval forecasts,
and moves on to quantitative stochastic models for
derivatives pricing (jump-diffusion models and Markov
regime-switching).
Zareipour (2008, Chapters 34; pages 52105 in the
authors Ph.D. Thesis from 2006, on which the book is
based) begins by reviewing linear time series models
(ARIMA, ARX, ARMAX) and nonlinear models (regres-
sion splines, neural networks), then uses them for fore-
casting hourly prices in the Ontario power market.
There are a few more books which touch upon the
topic of electricity price forecasting, but they generally
concentrate on modeling the stochastic price dynamics for
risk management and derivatives valuation, rather than on
day-ahead price forecasting; see for example Benth, Benth,
and Koekebakker (2008); Bunn (2004); Burger, Graeber,
and Schindlmayr (2007); Eydeland and Wolyniec (2003);
Fiorenzani (2006); Huisman (2009); Keppler, Bourbonnais
andGirod(2007); Lewis (2005), andWeber (2006). There is
also a recent monograph by Yan and Chowdhury (2010a),
based on the masters thesis of the first author, but it
considers only mid-term electricity price forecasting, with
a time frame of between one and six months. Although
mid-term EPF is important for resource reallocation,
maintenance scheduling, bilateral contracting, budgeting
and planning purposes, it is beyond the few hours to
few days ahead forecasting horizons that are typically
considered in the EPF literature.
Regarding review and survey articles, the situation
looks a little better: the first review papers were already
being published in the early 2000s. In an invited paper that
appeared in the Proceedings of the IEEE, Bunn (2000) re-
views some of the main methodological issues and tech-
niques which are related to the forecasting of daily loads
and prices in competitive power markets. He concludes
that the forecasting of loads and prices are mutually in-
tertwined activities and that game theory and the eco-
nomic perspective cannot be an accurate basis for daily
forecasts. He advocates the use of methods which involve
variable segmentation (separate models for each load pe-
riod), neural techniques (that are able to model the non-
linear behavior) and forecast combinations. Surprisingly,
the latter approach has been neglected at least in the
context of EPF until very recently, see Section 4.3. In
Chapter 5 of Skantze and Ilic (2001), the authors classify
electricity price models and existing relevant publications
into six groups, and discuss them very briefly in terms
of their objectives, characteristics, advantages and disad-
vantages. One of the model classes mentioned is that of
equilibrium (multi-agent; see Section 3.5) models, which
have been reviewed more extensively in the Ph.D. thesis
of Batlle (2002) and the review article of Ventosa, Ballo,
Ramos, and Rivier (2005) in Energy Policy. Both of these
publications discuss the different approaches to modeling
strategic bidding behavior in power markets, including the
Nash-Cournot framework and the supply function equi-
librium approach. Although such models cannot generally
provide accurate daily or hourly price forecasts, as was ob-
served by Bunn (2000), there have been some attempts
for the Spanish market (see e.g., Garcia-Alcalde, Ventosa,
Rivier, Ramos, & Relan, 2002).
In an IEEE Power & Energy Magazine discussion article
on real-world market representation with agent-based
models, Koritarov (2004) argues that the purpose of ABMis
not necessarily to predict the outcome of a system; rather,
it is to reveal and explain the complex and aggregate
system behaviors that emerge from the interactions of
the heterogeneous individual entities. At the same time,
he concludes that the ABM approach is positioned well
for performing short- and long-term electricity price
forecasting, resource forecasting and asset valuation.
Unfortunately, he does not provide any examples of EPF
applications of ABM. Weidlich and Veit (2008) also fail
to find any examples of EPF in a survey of agent-based
wholesale electricity market models in Energy Economics.
In another IEEE Power & Energy Magazine discussion
article, Amjady and Hemmati (2006) explain the need
for short-term price forecasts, review problems related to
EPF, and put forward proposals for such predictions. They
argue that time series techniques (AR, ARIMA, GARCH) are
generally only successful inthe areas where the frequency
of the data is low, such as weekly patterns . . . , which
is contradicted by the empirical evidence presented in
Section 3.8. Furthermore, they advocate the use of artificial
(or computational) intelligence and hybrid approaches
(neural networks, fuzzy regression, fuzzy neural networks,
cascaded architecture of neural networks, and committee
machines), which are capable of tracking the hard
nonlinear behaviors of hourly load and especially price
signals. In a later publication, Amjady (2012, Chapter
4) briefly reviews EPF methods, then focuses again on
artificial intelligence-based methods, and in particular
feature selection techniques and hybrid forecast engines.
He also discusses forecast error measures, the fine tuning
of model parameters, and price spike predictions.
In the year 2009, two similar survey articles, co-
authored by the same three researchers, appeared in
parallel in the International Journal of Electrical Power and
Energy Systems andthe International Journal of Energy Sector
Management. Aggarwal, Saini, and Kumar (2009a) review
47 time series and neural network papers published
between 1997 and 2006 in terms of the model type
and architecture, forecast horizon(s), model input and
output variables, preprocessing and datasets used. They
conclude that there is no systematic evidence of out-
performance of one model over the other models on a
consistent basis, which may be attributed to the large
differences in price developments (...) in different power
markets. In a more recent in terms of the publications
reviewed article, Aggarwal, Saini, and Kumar (2009b)
also compare time series and neural network papers.
They classify EPF models as falling into one of three
categories (although differently from Aggarwal et al.,
2009a): heuristics (nave, moving average), simulations
(production cost and game theoretical) and statistical
models, where the last category somewhat surprisingly
includes both time series (regression) and artificial
intelligence models. They expand the analysis to include
quantitative comparisons of (i) the forecasting accuracy
and (ii) the computational speed of different forecasting
techniques. In our opinion, the value of (i) is disputable.
Even if the forecasting accuracy is reported for the
same market and the same out-of-sample (forecasting)
test period, the errors of the individual methods are
not truly comparable if different in-sample (calibration)
periods are used. Moreover, the implementation of the
algorithms differs between software packages, and is
generally very sensitive to the initial conditions in
the case of nonlinear or multi-parameter models. It
may be impossible to replicate the results, even given
the exact model structure, as was reported by Weron
(2006) for the case of the multi-parameter transfer
function (ARMAX) model of Nogales, Contreras, Conejo,
and Espinola (2002). On the other hand, a table with the
computation speeds of different forecasting techniques
is interesting. Unfortunately, though, it cannot be used
to draw quantitative conclusions, due to the differences
in processors used, software implementations, calibration
periods, etc. Finally, Aggarwal et al. (2009b) conclude that
there is no hard evidence of out-performance of one
model over all other models on a consistent basis and that
longer test periods of one to two years should be used.
We cannot argue with these conclusions.
In a recent survey article published in the IEEE
Signal Processing Magazine, Chan et al. (2012) review
neural networks, support vector machines, time series
models (ARMA, ARMAX, GARCH), and functional prin-
cipal component analysis (FPCA) models for electricity
prices/load, wind and solar forecasting. They advocate the
use of multivariate factor models, and especially of the ro-
bust FPCA, which is shown to outperform both the stan-
dard FPCA and an AR model with a time varying mean in a
limited forecasting study.
In a chapter in the Wiley Encyclopedia of Electrical and
Electronics Engineering, Garcia-Martos and Conejo (2013)
review short- and medium-term EPF, with a focus on
time series models. Specifically, they consider ARIMA
and seasonal ARIMA models calibrated to hourly prices
for day-ahead predictions, and vector ARIMA (essentially
VAR) and unobserved component (i.e., factor) models for
medium-term horizons. Sadly, in the most novel part on
factor models, the authors limit the discussion to their
ownapproach(Garcia-Martos, Rodriguez, &Sanchez, 2011,
2012), and neither review nor compare other relevant
publications (see Section 4.4). Interestingly, though, the
chapter includes an introduction to the computation of
prediction intervals, a topic which is addressed very rarely
in the EPF literature.
In a short review article, Hong (2014) briefly discusses
spatial load forecasting, short-term load forecasting, EPF,
and two smart grid era research areas: demand-response
and renewable-generation forecasting. He classifies EPF
models into three groups: simulation methods (which
require a mathematical model of the electricity market,
load forecasts, outage information, and bids from market
participants), statistical methods, and AI methods. Perhaps
the most important contribution of the paper is that the
author emphasizes the need for rigorous out-of-sample
testing of the different methods proposed in the literature.
We will return to this issue in Section 4.5.
In the most recent survey of structural models,
published as a chapter in the book Quantitative Energy
Finance, Carmona and Coulon (2014) present a detailed
analysis of the structural approach for electricity modeling,
emphasizing its merits relative to traditional reduced-
form models. Building on several recent articles, they
advocate a broad and flexible structural framework for
spot prices, incorporating demand, capacity and fuel prices
in several ways, while calculating closed-form forward
prices throughout.
The above-mentioned articles, book chapters and Ph.D.
theses are complemented by a few survey conference
papers of varying quality. Niimura (2006) studies over 100
papers and classifies them as either simulation models
(production cost and game theoretical) or statistical
models (which again include time series, regression, and
artificial intelligence models). Haghi and Tafreshi (2007)
construct a different classification in which they categorize
time series models as either stationary (including
ARIMA, ARIMA-Wavelet, ARXand ARMAXmodels) or non-
stationary (including neural networks, regime-switching
models, GARCH, jump-diffusions and mean-reversion
models). This is a very confusing classification, as some of
the stationary models are non-stationary in a statistical
sense (for instance, ARIMA), while some of the non-
stationary models are stationary (for instance, mean-
reversion models)! Daneshi and Daneshi (2008) consider
over 100 papers and classify them as time series models,
neural networks, fuzzy set models, fuzzy neural networks
and other techniques. Similar in scope are the papers
of Hu, Taylor, Wan, and Irving (2009) and Negnevitsky,
Mandal, and Srivastava (2009), together with the more
recent survey of Cerjan, Krzelj, Vidak, and Delimar (2013).
3. What and how are we forecasting?
3.1. The electricity spot price
Unlike most other commodity or financial markets, the
electricity spot market is typically a day-ahead market
that does not allow for continuous trading. This is a result
of system operators requiring advance notice in order
to verify that the schedule is feasible and falls within
transmission constraints. In a day-ahead market, agents
submit their bids and offers for the delivery of electricity
during each hour (or a shorter load period) of the next day
before a certain market closing time, see Fig. 4. Thus, when
dealing with the modeling and forecasting of intraday
electricity prices, it is important to remember that, in
most markets, prices for all contracts of the next day are
determined at the same time using the same available
information (Huisman, Huurman, & Mahieu, 2007; Pea,
2012).
The genuine role of an organized market for electricity
(like a power exchange or a power pool) is to match the
supply and demand of electricity so as to determine
the market clearing price (MCP). Typically, the MCP is
established in an auction, conducted once per day, as
the intersection between the supply curve (constructed
from aggregated supply bids) and the demand curve
(constructed from aggregated demand bids) or the system
operator estimated demand (inone-sided auctionmarkets,
like in Australia or Spain), for each of the load periods; see
Fig. 5. Buy (sell) orders are accepted in order of increasing
(decreasing) prices until the total demand (supply) is
met. Note that bids with negative prices are allowed
in many markets, potentially leading to negative prices
when the demand is very low (the costs of shutting down
and ramping up a power plant unit can exceed the loss
from accepting negative prices) or the production from
renewable sources is very high (most notably from wind),
see e.g. Cutler, Boerema, MacGill, and Outhred (2011),
Fanone, Gamba, and Prokopczuk (2013), Keles, Genoese,
Mst, and Fichtner (2012). Recall that in a uniform-price
(or marginal) auction market, buyers with bids above (or
equal to) the MCP pay that price, and suppliers with offers
below(or equal to) the MCP are paid the same price. Hence,
on 3.1.2014, hour 1819, a supplier would have been paid
30.94 EUR/MWh for the quantity sold in the day-ahead
Elspot market at NordPool, regardless of his actual bid(and
his marginal costs), as long as it was at or below 30.94
EUR/MWh; see the left panel in Fig. 5. In contrast, in a
pay-as-bid (or discriminatory) auction, a supplier would be
paid exactly the price he bid for the quantity transacted; in
effect, he would be paid an amount that corresponds more
closely to his marginal costs. Both approaches have both
pros and cons, and the choice between themis not obvious.
However, most market designs have adopted the uniform-
price auction, with the UKunder NETAbeing one of the few
exceptions.
When there is no transmission congestion, the MCP
is the only price for the entire system. However, when
there is congestion, locational marginal prices (LMP) or
zonal clearing prices differ from the system price and from
each other. For smaller and medium-sized markets (like
the German EEX, Polish GEE, Scandinavian Nord Pool or
Spanish OMEL), the systemprice is usually established, but
for larger markets (like the North American PJM), zonal
prices or prices for major market hubs are computed. Inter-
estingly, transmission congestion itself can be predicted in
the short-term, as was shown by Lland, Ferkingstad, and
Wilhelmsen (2012) for the South Norway (NO1) price area
of the Nord Pool system.
Fig. 4. The spot electricity market is typically a day-ahead auction market that does not allowfor continuous trading. Before a certain market closing time
on day d 1, agents must submit their bids and offers for the delivery of electricity during each hour (or half-hour) of day d.
Fig. 5. Left panel: In a power exchange, like the Scandinavian Nord Pool, the market clearing price (MCP) is established through a two-sided auction as
the intersection between the supply curve (constructed from aggregated supply bids) and the demand curve (constructed from aggregated demand bids).
Here, the MCP is 30.94 EUR/MWh for Friday, 3.1.2014, hour 1819. Right panel: A hypothetical market cross for a one-sided auction (power pool). Note
that bids with negative prices are allowed in many markets, potentially leading to negative prices a behavior which is not generally observed in other
financial or commodity markets.
Nodal prices are the sum of generation marginal costs
and transmission congestion costs, and can be different
for different buses (or nodes), even within a local area.
They are the ideal reference, because the electricity value
is based on where it is generated and delivered. However,
they generally lead to higher transaction costs and a
greater complexity of the pricing mechanism (Weron,
2006). On the other hand, zonal prices may differ between
different zones or areas, but are the same within a
zone, i.e., a portion of the grid within which congestion
is expected to occur infrequently or has relatively low
congestion-management costs. Nodal (locational) pricing
developed in the highly meshed North American networks,
where transmission lines criss-cross the electricity system.
In Australia, where the network structure is simpler,
zonal pricing was implemented successfully. Although the
European network is rather complex, it is evolving into a
zonal market, often with an entire country constituting a
zone.
For very short time horizons before delivery, the
(transmission) system operator (TSO, SO) operates the
so-called balancing (or real-time) market. This technical
market is used to price deviations in supply and demand
from day-ahead or long-term contracts. The TSO needs to
be able to call in extra production at very short notice,
since the deviations must be corrected on a continuous
basis in order to ensure system balance. It should be
noted that the balancing market is not the only technical
market. To minimize the reaction time in the case of
deviations insupply anddemand, the systemoperator runs
an ancillary services market, which typically includes the
down regulation service, the spinning and non-spinning
reserve services, and the responsive reserve service. Day-
ahead, balancing and ancillary services markets serve
different purposes and are complementary. The modeling
and forecasting of prices from the latter two markets
is rather rare in the literature, but there are some
exceptions. For instance, Ma, Luh, Kasiviswanathan, and
Ni (2004) develop neural network models for forecasting
real-time LMP before and after the day-ahead market
is cleared, and test them using data from the PJM
and New England markets; Olsson and Soder (2008)
build a model for balancing prices at Nord Pool using
combined seasonal ARIMA and discrete Markov processes;
and Czapaj, Tomasik, and Lubicki (2009) forecast balancing
market and power exchange day-ahead prices jointly in
Poland using a neural network. More recently, recognizing
the fact that emerging smart grid technologies and the
large-scale integration of variable resources into the
grid have led to a growth of the market for ancillary
services, Wang, Zareipour, and Rosehart (2014) investigate
the application of reduced-form approaches (MRJD and
MRS, see Section 3.7) for modeling the behaviors of
operating reserve and regulation prices in the Ontario and
New York markets. The patterns and characteristics of the
prices of ancillary services differ considerably from those
of day-ahead electricity prices, with the particular features
of a lower price level, higher variability and more frequent
andextreme spikes. The last feature inparticular makes the
prices for ancillary services more difficult to predict.
Some markets like the Australian National Electricity
Market (NEM) and the Ontario Electricity Market (OEM)
follow a single settlement real-time structure (Zareipour,
2008). In such a system, bids must be submitted to
the market operator on the pre-dispatch day, but the
volume can then be revised up to 5 (NEM) or 10 (OEM)
minutes prior to the dispatch time without any restriction.
The prices are set by the market operator each 5 min,
and the spot prices are then determined in half-hourly
(NEM) or hourly (OEM) trading intervals, as an average
over the 5-min prices. As was pointed out by Higgs
and Worthington (2008), Janczura, Trueck, Weron, and
Wolff (2013) and Zareipour, Bhattacharya, and Canizares
(2007), the Australian and Ontario electricity markets
are significantly more volatile and spike-prone than
most other markets. This has been confirmed by various
short-term price and spike forecasting studies for the
Australian(Amjady &Keynia, 2009; Becker, Hurn, &Pavlov,
2007; Christensen, Hurn, & Lindsay, 2012; Dong, Wang,
Jiang, & Wu, 2011) and Ontario (Aggarwal, Saini, & Kumar,
2008; Lei & Feng, 2012; Mandal, Haque, Meng, Martinez,
& Srivastava, 2012; Rodriguez & Anders, 2004) power
markets. It is no surprise that Aggarwal et al. (2009b)
conclude in their review paper that the accuracy levels
achieved by the various models for day-ahead forecasts are
higher than those achieved for real-time forecasts.
Finally, it should be noted that although we use the
terms spot andday-ahead interchangeably here, the former
need not necessarily refer to the day-ahead market. The
European convention is to refer to the day-ahead price
as the spot price. However, in the US, the term spot price
is typically reserved for the intra-day real-time market,
while the day-ahead price is called the forward price (see
e.g. Longstaff & Wang, 2004). Nowadays, some markets
in Europe (e.g., in the UK) also allow continuous trading
for individual load periods, up to a few hours before
delivery. With the shifting of volume from the day-ahead
to balancing markets, the termspot is also being used more
and more often in Europe to refer to the real-time market.
The average of the 24 hourly (or 48 half-hourly) prices is
called the daily price, the daily spot price or the baseload
price. The average of prices for the on-peak hours (typically
8 amto 8 pm) is called the peakload price. These daily price
conventions generally refer to day-ahead prices. In single
settlement real-time markets, the averages are computed
for real-time prices.
3.2. Forecasting horizons
It is customary to talk about short-, medium- and long-
termelectricity price forecasting, but there is no consensus
in the literature as to what the thresholds should actually
be. Short-term EPF generally involves forecasts from a few
minutes up to a few days ahead, and is of prime impor-
tance in day-to-day market operations, as was discussed in
Section 3.1. Medium-term time horizons, from a few days
to a few months ahead, are generally preferred for balance
sheet calculations, risk management and derivatives pric-
ing. In many cases, evaluation is based not on the actual
point forecasts, but on the distributions of prices over cer-
tain future time periods. As this type of modeling has a
long-standing tradition in finance, an inflowof finance so-
lutions is observed readily (see Section 3.7). Finally, the
main objective of long-term EPF with lead times mea-
sured in months, quarters or even years is investment
profitability analysis and planning, such as determining
the future sites or fuel sources of power plants. As Ventosa
et al. (2005) remark, capacity-investment decisions are the
main variables, and unit-commitment decisions are usu-
ally neglected in this context. While similar tools and tech-
niques can be used for short- and medium-term horizons,
long-termhorizons generally require a totally different ap-
proach (which is beyond the scope of this review).
3.3. Evaluating point forecasts
The vast majority of EPF papers are concerned only
with point forecasts (see Sections 4.2 and 4.5.2 for a
discussion of interval and density forecasts). The most
widely used measures of accuracy are those based on
absolute errors: AE
h
= |P
h

P
h
|, where P
h
is the actual and
P
h
the predicted price for load period h. In particular, for
hourly point forecasts, the daily/weekly mean absolute error
(MAE) is computed as the mean of T = 24 or 168 absolute
errors. Since absolute errors are hard to compare between
different datasets, many authors use measures based on
absolute percentage errors: APE
h
= AE
h
/P
h
. By far the most
popular is the mean absolute percentage error (MAPE),
which is computed as the mean of T absolute percentage
errors. The MAPE measure works well in load forecasting,
since load values are significantly higher than zero, but
MAPE can be misleading when applied to electricity prices.
In particular, when electricity prices are close to zero,
MAPE values become very large, regardless of the actual
absolute errors. On the other hand, when electricity prices
spike, the resulting MAPE values are small, irrespective
of the absolute differences. Moreover, for negative spot
prices, they become negative and hard to interpret.
In a more general point forecasting context, Hyndman
and Koehler (2006) compare a number of popular mea-
sures of accuracy and find them to be degenerate in com-
monly occurring situations. They advocate the use of scaled
errors as a robust alternative to using percentage errors
when comparing forecast accuracies across series on dif-
ferent scales. For a non-seasonal time series, a scaled error
uses one-step-ahead nave forecasts (based on the most re-
cent observation; m = 1 in Eq. (1)). However, for seasonal
time series, a scaled error should be defined using sea-
sonal nave forecasts instead (Hyndman&Athanasopoulos,
2013). The resulting (seasonal) mean absolute scaled error is
defined as:
MASE
T,m
=
1
T
T
h=1
P
h

P
h
1
Tm
T
h=m+1
|P
h
P
hm
|
, (1)
where mis the length of the cycle; see also Section 3.8.1 for
a discussion of similar-day forecasts in electricity markets.
When working with hourly electricity prices, we can set
m = 24 and T = 168 to obtain a weekly MASE. However, if
we want to take the weekday/weekend effect into account,
we have to set m = 168 and T significantly greater than
168. A scaled error has the nice interpretation that it is
less than one if it arises from a better forecast than the
average m-step-ahead nave forecast computed in-sample;
conversely, if the forecast is worse than the nave forecast,
it is greater than one.
Scaled errors have not been used extensively in en-
ergy economics thus far. To the best of our knowledge,
only Garcia-Ascanio and Mate (2010) and Jonsson, Pin-
son, Nielsen, Madsen, and Nielsen (2013) utilize absolute
or squared scaled errors in the EPF context. Alternative
normalizations have been proposed instead, see for exam-
ple Misiorek, Trck, andWeron(2006); Nogales andConejo
(2006); Shahidehpour et al. (2002); Weron and Misiorek
(2008), and the references in the paragraphs below. Prob-
ably the most common approach is to normalize the abso-
lute error by the average price obtained in the evaluation
interval (e.g. a day, a week). This yields the daily- or weekly-
weighted mean absolute errors (DMAE, WMAE; also known
as the mean daily/weekly errors, MDE, MWE):
DMAE
(T=24)
, WMAE
(T=168)
=
1
P
T
MAE
T
=
1
T
T
h=1
P
h

P
h
P
T
, (2)
where

P
T
=
1
T
T
h=1
P
h
is the mean price in the time
interval T.
Apart from l
1
-type norms, square or l
2
-type norms
are also used, usually in the more econometric papers.
Perhaps the most popular are the daily and weekly root
mean square errors (RMSE; sometimes denoted by DRMSE
and WRMSE, see e.g. Weron, 2006), calculated as the
square root of the average of squared differences between
the predicted and actual prices:
RMSE
(T=24 or 168)
=
_
1
T
T
h=1
_
P
h

P
h
_
2
. (3)
Like in the absolute error-based measures, the squared
differences (P
h

P
h
)
2
in the above formula can also be
normalized by the square of the current actual price to
yield the root mean square percentage error (RMSPE; see
Hyndman & Koehler, 2006), or by the square of the mean
daily (or weekly) price to yield the daily- or weekly-
weighted root mean square errors (DRMSE, WRMSE), or by
1
T24
T
h=25
(P
h
P
h24
)
2
to yield the (seasonal) root mean
square scaled error (RMSSE; see Jonsson et al., 2013).
Finally, we have to note that there is no industry
standard, and the error benchmarks used in the literature
vary a lot. As Weron (2006) observes, this may lead to
confusion, since the names are not used consistently.
For instance, Contreras, Espnola, Nogales, and Conejo
(2003); Garcia, Contreras, van Akkeren, and Garcia (2005)
and Nogales et al. (2002) define the mean weekly error
as the weekly MAPE (literally, as the average of the
seven daily average prediction errors, i.e., daily MAPE
values), while Conejo, Contreras, Espinola, and Plazas
(2005) and Conejo, Plazas, Espnola, and Molina (2005) use
Eq. (2) with T = 168. Likewise, in the latter three papers,
the weekly RMSE, denoted by

FMSE, is computed using
Eq. (3) with T = 168, while in the former two articles the
normalization by

1/168 is missing. As a result, laborious
multi-paper comparisons, like that performed by Aggarwal
et al. (2009b), have to be treated with caution and a
dose of skepticism. In particular, neither Conejo, Contreras
et al. (2005) nor Conejo, Plazas et al. (2005) use the MAPE
measure, as was suggested by Aggarwal et al. in their
Tables III and IV.
3.4. Overview of modeling approaches
Nearly all of the review and survey publications
discussed in Section 2.2 offer their own classifications
of the various approaches that have been developed for
analyzing and predicting electricity prices. Some of them
are better, some are worse, but all have many things
in common. Without loss of generality, we take the
classification of Weron (2006) as a starting point, with six
groups of models. We then alter it by combining the first
two groups into one larger class (due to the decreasing
popularity of production-cost models and the increasing
use of simulation models):
Multi-agent (multi-agent simulation, equilibrium, game
theoretic) models, which simulate the operation of
a system of heterogeneous agents (generating units,
companies) interacting with each other, and build the
price process by matching the demand and supply in
the market.
Fundamental (structural) methods, which describe the
price dynamics by modeling the impacts of important
physical andeconomic factors onthe price of electricity.
Reduced-form (quantitative, stochastic) models, which
characterize the statistical properties of electricity
prices over time, with the ultimate objective of
derivatives evaluation and risk management.
Statistical (econometric, technical analysis) approaches,
which are either direct applications of the statistical
techniques of load forecasting or power market imple-
mentations of econometric models.
Computational intelligence (artificial intelligence-based,
non-parametric, non-linear statistical) techniques, which
combine elements of learning, evolution and fuzziness
to create approaches that are capable of adapting to
complex dynamic systems, and may be regarded as
intelligent in this sense.
Finally, we should mention that many of the modeling and
price forecasting approaches considered in the literature
are hybrid solutions, combining techniques from two or
more of the groups listed above. Their classification is
non-trivial, if indeed it is even possible. We illustrate the
proposed taxonomy in Fig. 6. The main model types will be
reviewed in Sections 3.53.9.
3.5. Multi-agent models
Forecasting wholesale electricity prices used to be
a straightforward, though laborious, task. It generally
concerned medium- and long-term time horizons, and
involved matching demand estimates to the supply,
obtained by stacking up existing and planned generation
units in order of their operating costs. These cost-
based models (production-cost models, PCM) had the
capability to forecast prices on an hour-by-hour, bus-by-
bus level (see for example Wood & Wollenberg, 1996,
for a comprehensive discussion). However, they ignored
strategic bidding practices, including the execution of
market power. They were appropriate for regulated
markets with little price uncertainty, a stable structure and
no gaming, but are not suitable for competitive electricity
markets. Equilibrium (game theoretic) approaches may be
viewed as generalizations of cost-based models, amended
with strategic bidding considerations. These models are
especially useful in predicting expected price levels
in markets with no price history, but known supply
costs and market concentration. On the other hand,
the increasingly popular adaptive agent-based simulation
techniques can address features of electricity markets that
static equilibrium models ignore.
In an excellent reviewpaper, Ventosa et al. (2005) iden-
tify three main electricity market modeling trends: op-
timization, equilibrium and simulation models. In their
classification, optimization models focus on the profit
maximization problem for one of the firms competing in
the market. As such, they are not useful in the EPF context,
and will not be reviewed here. The equilibriummodels dis-
cussed below (Nash-Cournot framework, supply function
equilibrium) represent the overall market behavior, taking
into consideration competition among all participants. Fi-
nally, simulation models are an alternative to equilibrium
models when the problemunder consideration is too com-
plex to be addressed within a formal equilibrium frame-
work. Since the equilibriumandsimulationmodels defined
by Ventosa et al. share many common features, we have
decided to consider them jointly in one wide multi-agent
class.
3.5.1. Nash-Cournot framework
Inthe Nash-Cournot framework, electricity is treatedas a
homogeneous good, and the market equilibrium is deter-
mined through the capacity setting decisions of the sup-
pliers. Unfortunately, these models tend to provide prices
higher than those observed in reality. Researchers have ad-
dressed this problem by introducing the concept of con-
jectural variations, see for example Day, Hobbs, and Pang
(2002), Garcia-Alcalde et al. (2002) andVives (1999), which
aims to represent the fact that rivals react to high elec-
tricity prices by producing more. For sample applications
of the Nash-Cournot framework, see Borenstein, Bushnell,
and Knittel (1999); Cabero et al. (2005); Rubin and Babcock
(2013) and Sapio and Wyomaska (2008). Although their
approach is hybrid in nature, Ruibal and Mazumdar (2008)
provide one of the very fewapplications of this framework
to EPF. A fundamental bid-based stochastic model is pro-
posed for predicting electricity hourly prices and average
prices in a given period. Two sources of uncertainty are
considered: the availability of the generating units and de-
mand. The results show that as the number of firms in the
market decreases, the expected values of prices increase
by a significant amount. The variances for the Cournot
model also increase, but those for the SFE model (see Sec-
tion 3.5.2) decrease. Ruibal and Mazumdar also demon-
strate that an accurate temperature forecast can reduce
the prediction error of the electricity price forecasts sig-
nificantly.
3.5.2. Supply function equilibrium
The second approach models the price as the equilib-
rium of companies bidding with supply (and possibly de-
mand) curves into the wholesale market. Calculating the
supply function equilibrium (SFE) requires a set of differen-
tial equations to be solved, rather than the typical set of
algebraic equations that arises in the Nash-Cournot frame-
work. Thus, these models have considerable limitations
concerning their numerical tractability. To speed up com-
putations, the demand can be aggregated into blocks. This
in turn leaves the extreme values out of the analysis, which
we are not prepared to accept when focusing on EPF or
risk management. Furthermore, as Bolle (2001) empha-
sizes, supply curve bidding will only lead to results which
differ from the Nash-Cournot equilibrium if the demand
uncertainty (or another source of uncertainty) leads to an
ex-ante undetermined equilibrium. Otherwise, the supply
bidding collapses to one point, which corresponds to the
Nash-Cournot equilibrium.
For decreasing the numerical complexity of general SFE
models, linear SFE models have been proposed. In such
models, the demand is linear (or, more precisely, affine;
at each moment in time the demand as a function of price
has a non-zero intercept and a constant negative slope, see
Baldick, Grant, & Kahn, 2004), marginal costs are linear or
affine, and SFE can be obtained in terms of either linear
or affine supply functions. The market clearing condition,
yielding the price at time t, is
m
j=1
q
j
(p
t
) = D
t
,
assuming that a solution exists. The bid curve q
j
:
[P
min
, P
max
] [0, U
j
] is defined by
q
j
= q
j
(p
t
) =
j
(p
t

j
),
Fig. 6. A taxonomy of electricity spot price modeling approaches. The main model types are reviewed in Sections 3.53.9, with a special emphasis on their
forecasting capabilities.
where
j
is the intercept,
j
is the slope of the supply
function for the jth firm, U
j
is the generation capacity
for this firm, and the system demand curve D(p
t
) is
assumed to be linear in p
t
. All firms receive the marginal
clearing price for their supply. Since the supply functions
are non-decreasing and the market clearing price is
the same for all players, this market clearing condition
maximizes the (revealed) social welfare when there is no
transmission congestion. This framework has been used
extensively for the analysis of bidding strategies (Borgosz-
Koczwara, Weron, & Wyomaska, 2009; Niu, Baldick, &
Zhu, 2005), market power and market design (Baldick
et al., 2004; Holmberg, Newbery, & Ralph, 2013), and
congestion management (Hobbs, Metzler, & Pang, 2000);
but electricity price forecasting applications have been
very limited (see e.g. Ruibal & Mazumdar, 2008).
3.5.3. Strategic production-cost models
A third, less popular static equilibrium approach has
been proposed by Batlle (2002) and Batlle and Barqun
(2005) as a modification of the traditional production-cost
models. The strategic PCM (SPCM) takes agents bidding
strategies into account, based on conjectural variation.
Each agent tries to maximize its own profits, taking into
account its cost structures and the expected behaviors of
its competitors, modeled through a strategic parameter,
which represents the slope of the residual demand
function for each production level of the generator.
When simulating the supply curve building process, the
SPCM assumes that the firm just knows its costs and its
conjecture about the derivative of its residual demand
function. As no iterations are made, firms do not have the
chance to refine their bids and take into account rivals
reactions (as in SFE models). Compared with the Nash-
Cournot and SFE models, the main advantage of the SPCM
is its computational speed, whichmakes it suitable for real-
time analysis.
3.5.4. Agent-based simulation models
The static equilibrium models discussed above are
based on a formal definition of equilibrium, expressed in
the form of a system of algebraic or differential equations.
Even if the set of equations has a solution, it is often
very hard to find, and the modeler has to resort to
heuristics to solve the problem (Day et al., 2002; Ventosa
et al., 2005). Moreover, such modeling approaches have
limitations in the way in which the competition between
participants can be represented. On the other hand, agent-
based simulation models do not have these limitations,
while being not much harder to solve.
Over the last two decades, agent-based computational
economics (ACE) has become a widely acceptedapproachto
solving both theoretical and practical problems in energy
economics (see e.g. Guerci, Rastegar, & Cincotti, 2010;
Kowalska-Pyzalska, Maciejowska, Suszczyski, Sznajd-
Weron, & Weron, 2014; Sun & Tesfatsion, 2007; Weidlich
& Veit, 2008). The basic tool of ACE an agent-based model
(ABM; sometimes referred to as a multi-agent system or
a multi-agent simulation) is a class of computational
structures and rules for simulating the actions and
interactions of autonomous agents (whether individuals or
collective entities, such as organizations or groups), with
the ultimate objective being to assess their effects on the
system as a whole.
One of the first applications of ACE to modeling the
strategic behavior observed in electricity markets was
described in the paper by Bower and Bunn (2000), who
test a number of market designs which are relevant for
the changes that have taken place in the England and
Wales market. They conclude that daily bidding, together
withuniformpricing, yields the lowest prices, while hourly
bidding under the pay-as-bid system yields the highest
prices. In a similar context, Day and Bunn (2001) propose
a simulation model for analyzing the potential for market
power. This agent-free simulation approach is similar to
the SFE scheme, but it provides a more flexible framework
that allows for a consideration of actual marginal cost data
and asymmetric firms.
In a review article, Koritarov (2004) argues that the
purpose of ABM is not necessarily to predict the outcome
of a system, but rather to reveal and explain the complex
and aggregate system behaviors that emerge from the
interactions of the heterogeneous agents. Indeed, if the
Scopus query given in footnote 1 is appended with AND
(agent-based OR multi-agent), it yields
five publications, only three of which are related to EPF.
This did not prevent Koritarov from concluding that the
ABM approach is positioned well for the performance of
short- and long-term electricity price forecasting. Perhaps
with the development of more powerful processors and
cloud computing, ABMwill someday provide efficient tools
for EPF.
Currently, ABM are merely elements of complex hybrid
EPF systems, rather than being the source of price forecasts
themselves. For instance, Gao, Bompard, Napoli, and Zhou
(2008) present a monitoring system which consists of
two units: a price forecast module, which delivers input
variables to the multi-agent market simulator. The two
units cooperate to build a monitoring systemfor predicting
future power market scenarios and to deliver market
clearing and production schedule information. Guerci,
Ivaldi, and Cincotti (2008) develop an artificial power
exchange, called the Genoa market, and are able to obtain
simulated price trajectories with properties observed for
peak- and off-peak prices in the Italian market. However,
they do not focus on forecasting. Similar in spirit is
the work by Jaboska and Kauranne (2011), who build
two multi-agent models based on a Capasso-Morale-type
population dynamics approach and use themto reproduce
the statistical features of Nord Pool spot prices.
Chatzidimitriou, Chrysopoulos, Symeonidis, and Mitkas
(2012) use Cassandra, a dynamic platform for the de-
velopment of multi-agent systems, to generate load and
price predictions for the day-ahead market in Greece. They
propose a hybrid scheme in which autonomously adaptive
recurrent neural networks (see Section 3.9.3) are encapsu-
lated into Cassandra agents. Sousa, Pinto, Vale, Praca, and
Morais (2012) present another hybrid ABM-based method
that aims to provide market players with strategic bid-
ding capabilities, thus allowing themto achieve the highest
possible gains in the market. Their method uses a neural
network as an auxiliary forecasting tool for predicting
electricity market prices. Through the analysis of predic-
tion error patterns, the simulation method predicts the
expected error for the next forecast, and uses it to adapt
the actual forecast. In a very recent paper, Ladjici, Tiguer-
cha, and Boudour (2014) investigate the use of compet-
itive co-evolutionary algorithms to calculate suppliers
optimal strategies in a deregulated electricity market. In
their model, agents can take part in both spot and for-
ward transactions, and act strategically in order to max-
imize their overall profit. The strategic interactions of
market agents are modeled as a non-cooperative game,
and a competitive co-evolutionary algorithmis used to cal-
culate the Nash equilibrium strategies, thus ensuring the
best outcome for each agent.
3.5.5. Strengths and weaknesses
Onthe one hand, multi-agent models andagent-based
models in particular are a class of extremely flexible tools
for the analysis of strategic behavior in electricity mar-
kets. On the other hand, this freedom is also a weakness,
as it requires the assumptions embedded in the simulation
to be justified, both theoretically and empirically. A num-
ber of components have to be defined: the players, their
potential strategies, the ways in which they interact, and
the set of payoffs. Obviously, a substantial modeling risk is
present. While in classical power pools the sellers are gen-
erators, and their characteristics are identifiable through
their assets directly, inpower exchanges every type of mar-
ket participant can be a seller. For instance, a distribution
company that has over-contracted in the bilateral market
can be a seller in the power exchanges spot market. Thus,
the problemof identifying the relevant market players and
their strategies becomes highly nontrivial.
Moreover, despite the few forecasting applications dis-
cussed above, multi-agent models generally focus on qual-
itative issues rather than quantitative results. They may
provide insights as to whether or not prices will be above
marginal costs, and how this might influence the players
outcomes. However, they pose problems if more quantita-
tive conclusions have to be drawn, particularly if electricity
prices have to be predicted with a high level of precision.
3.6. Fundamental models
The next class of models, known as fundamental or
structural models, tries to capture the basic physical and
economic relationships which are present in the produc-
tion and trading of electricity. The functional associations
between fundamental drivers (loads, weather conditions,
system parameters, etc.) are postulated, and the funda-
mental inputs are modeled and predicted independently,
often via statistical, reduced-form or computational intel-
ligence techniques. Moreover, many of the EPF approaches
considered in the literature are hybrid solutions with time
series, regression and neural network models using fun-
damental factors like loads, fuel prices, wind power or
temperature as input variables, see e.g. Gonzalez, Con-
treras, and Bunn (2012); Karakatsani and Bunn (2008);
Kristiansen (2012); Liebl (2013); and Weron and Misiorek
(2008). In general, two subclasses of fundamental mod-
els can be identified: parameter rich models and parsimo-
nious structural models of supply and demand. For a very
good introduction to the fundamentals behind fundamen-
tal models, we refer to Burger et al. (2007, Chapter 4).
3.6.1. Parameter-rich fundamental models
Models from the first subclass are often developed
as proprietary, in-house products, and therefore, their
details are not disclosed publicly. Most of the results
published relate to hydro-dominant power markets. In
particular, Johnsen (2001) presents a supplydemand
model for the Norwegian power market from a time
before the common Nordic market had started. He uses
hydro inflow, snow and temperature conditions to explain
spot price formation. Eydeland and Wolyniec (2003)
develop a hybrid fundamental model and calibrate it to
data from ERCOT, NYPOOL and PJM. They start with the
processes for the primary drivers (such as fuels, outages
and temperature/demand), then construct the bid stack
transformation and obtain electricity prices. The simulated
price processes exhibit spikes, mean reversion, fat tails
of the price distributions, and a correct forward price
volatility structure.
Vahvilinen and Pyykknen (2005) build an even more
parameter-rich fundamental model for the Nordic market.
Considering stochastic climate factors like temperature
and precipitation, they model the hydrological inflow
and snow-pack development that affect hydro power
generation, the major source of electricity in Scandinavia.
Using 27 scalar parameters (13 climate, 4 demand and
10 supply parameters) and 29 formulas defining the
relationships between the fundamental variables, they
arrive at the spot price formula: the production volume
weighted average of the supply price of condensing power
and the supply price of hydro-power. The weight is a sum
of the amount of condensing production and the amount of
regulated hydro-production. Vahvilinen and Pyykknen
show that their model is able to capture the observed
fundamentally motivated market price movements on a
monthly scale.
3.6.2. Parsimonious structural models
The subclass of much simpler structural models can be
traced back to Barlow (2002). Starting from an empirical
analysis of market supply anddemandcurves, he builds the
spot price process by applying the inverse of the BoxCox
transformation (which includes an exponential function
as a special case) to an OrnsteinUhlenbeck process, see
Eq. (5) below. As a result, Barlow obtains a jumpless spot
price model which can exhibit spikes, and calibrates it to
data from the Alberta and California markets.
Inthe same spirit, Kanamura and

Ohashi (2007) define a
hockey-stick shaped supply curve (see Fig. 7) that matches
the empirically observed curves better than the inverse of
the BoxCox transformation:
P
t
= f (S
t
) =
_
_
_
1
+
1
D
t
for D
t
z s,
a + bD
t
+ cD
2
t
for D
t
(z s, z + s),
2
+
2
D
t
for D
t
z + s,
(4)
where z is the mid-point of the domain of the quadratic
curve stretchedbetweenzs and z+s,
1,2
and
1,2
are the
intercepts andslopes, respectively, of the linear parts of the
supply curve (to the left and right of the quadratic regime),
and a, b and c are the coefficients of the quadratic curve.
Then, combine this with an inelastic vertical demand curve
with horizontal stochastic deviations X
t
= D
t

D
t
driven
by a mean-reverting process of the form:
dX
t
= ( X
t
)dt + dW
t
, (5)
where is the speed of mean-reversion,

is the long term

mean-reversion level, is the volatility and dW
t
are the in-
crements of a standard Wiener process (i.e., Brownian mo-
tion). The above stochastic differential equation is known
in mathematics as the OrnsteinUhlenbeck process, and
was introduced to finance by Vasicek (1977), originally
for modeling interest rate dynamics. It is the backbone of
all reduced-form models for commodity prices, see Sec-
tion 3.7. Kanamura and

Ohashi fit their model to PJM price
and demand data, and show that it can generate electric-
ity price spikes (see the bottom panel of Fig. 7), and fits
the observed data better than a jump-diffusion model (see
Section 3.7.1). This is mainly because this simple structural
model incorporates the sudden and large increase in the
slope of the supply curve by using a hockey-stick shaped
function. In the second part of the paper, the authors then
use it to model the optimal operation policy for a pumped-
storage hydropower generator. In a follow-up paper,
Kanamura and

Ohashi (2008) use this model to show that
the transition probabilities of electricity prices cannot be
constant, and depend on both the current demand level
relative to the supply capacity and the trends of demand
fluctuation. Independently, Boogert andDupont (2008) use
a similar supplydemand framework to model the hourly
day-ahead price of electricity in the Dutch APXmarket, and
are quite successful at predicting spot price movements
24 h ahead. One of their main findings is that the reserve
margin should be included in a spot electricity model in or-
der to enhance the performance, see also the discussion in
Section 4.1.2.
Coulon and Howison (2009) develop a fundamental
model for spot electricity prices, based on stochastic
processes for the underlying factors (fuel prices, power
demand and generation capacity availability), as well as
a parametric form for the bid stack function that maps
these price drivers to the power price. Using observed bid
data, they find high correlations between the movements
of bids andthe corresponding fuel prices. Using a stochastic
model of the bid stack, Carmona, Coulon, and Schwarz
(2013) translate the demand for power and the prices
of generating fuels into electricity spot prices. The stack
structure allows for a range of generator efficiencies
per fuel type and for the possibility of future changes
in the merit order of the fuels. The derived spot price
process captures important stylized facts of historical
electricity prices, including both spikes and the complex
dependence upon its underlying supply and demand
drivers. Furthermore, under mild assumptions on the
distributions of the input factors, they obtain closed-form
formulas for electricity forward contracts and for spark and
dark spread options. In a similar context, Ad, Campi, and
Langren (2013) develop a structural risk-neutral model
in which a scarcity function is introduced to allow for
deviations of the spot price from the marginal fuel price,
thus leading to price spikes. Like Carmona et al. (2013),
they focus on pricing and hedging electricity derivatives,
and show that, when far from delivery, electricity futures
behave like a basket of futures on fuels.
Fig. 7. Daily Nord Pool spot price (top left panel) and consumption (mid left panel) in the Nordic region (Denmark, Finland, Norway, Sweden) over the
period 1.1.201231.12.2013. The Kanamura and

Ohashi (2007) supply function, see Eq. (4), is fitted here to the Nordic consumption-price data (top right
panel) and combined with a stochastic mean-reverting demand level, see Eq. (5), yielding a relatively spiky simulated spot price trajectory (bottom panel).
Note that the latter is a pure stochastic spot price component, without either weekly seasonality or the long-term cyclic component.
Two major challenges arise in the practical imple-
mentation of fundamental models. The first one is data
availability. Depending on the market, more or less infor-
mation on plant capacities and costs, demand patterns and
transmission capacities is available to the researcher or
practitioner for constructing such a model. Because of the
nature of fundamental data (which is often collected over
longer time intervals, such as weekly or monthly), pure
fundamental models are more suitable for medium-term
predictions than short-term. This is also true for the par-
simonious structural models. They are typically calibrated
to daily data, and ignore the fine relationships at the hourly
resolution. Their application, like that of the reduced-form
models (see Section 3.7), is generally limited to risk man-
agement andderivatives pricing. Infact, they canbe seenas
direct competitors of the former, allowing for a better de-
scription of the market fundamentals, though at the cost of
an increased complexity of the analytical calculations and
calibration procedures. For an extended discussion, see the
very recent review by Carmona and Coulon (2014).
The second challenge is the incorporation of stochastic
fluctuations of the fundamental drivers. In building the
model, we make specific assumptions about physical and
economic relationships in the marketplace, and therefore
the price projections generated by the models are very
sensitive to violations of these assumptions. Moreover,
the more detailed the model is, the more effort is
needed to adjust the parameters. Consequently, there
exists a significant modeling risk in the application of the
fundamental approach.
3.7. Reduced-form models
A common feature of the finance-inspired reduced-
form (quantitative, stochastic) models of price dynamics
is that their main intention is not to provide accurate
hourly price forecasts, but rather to replicate the main
characteristics of daily electricity prices, like marginal
distributions at future time points, price dynamics, and
correlations between commodity prices. Such models lie
at the heart of derivatives pricing and risk management
systems. If the price process chosen is not appropriate
for capturing the main properties of electricity prices,
the results from the model are likely to be unreliable.
At the same time, if the model is too complex, the
computational burden will prevent its use on-line in
trading departments (Weron, 2006). On the one hand, the
tools that are applied have their roots in methods that have
been developed for modeling other energy commodities or
interest rates (because of the mean-reversionproperty; see
e.g. Burger et al., 2007); on the other hand, they integrate
actuarial (claim arrival processes; see e.g. iek, Hrdle &
Weron, 2011) or econometric (abrupt changes in prices;
see e.g. Hamilton, 2008) mechanisms. In a way, the jump-
diffusion models that are reviewed next and the Markov
regime-switching models discussed in Section 3.7.2 offer
the best of the two worlds: they are trade-offs between
model parsimony and adequacy to capture the unique
characteristics of electricity prices.
Depending on the type of market under consideration,
stochastic techniques canbe dividedinto two mainclasses:
spot and forward price models. The former provide a
proper representation of the dynamics of spot prices,
which, in the wake of the deregulation of power markets,
becomes a necessary tool for trading purposes. Their main
drawback is the problem of pricing derivatives, i.e., the
identification of the risk premiumlinking spot and forward
prices (or those of other derivatives); for a discussion, see
the recent review by Weron and Zator (2014a). On the
other hand, forward price models allow for the pricing
of derivatives in a straightforward manner (but only of
those written on the forward price of electricity). However,
they too have their limitations; most importantly, the
lack of data that can be used for calibration and the
inability to derive the properties of spot prices from the
analysis of forward curves. In this review, we focus on
spot price models. Forward price models are the domain
of mathematical finance, and we refer to Benth et al.
(2008) and Eydeland and Wolyniec (2003) for extended
discussions. As Borak and Weron (2008) and Fleten
and Lemming (2003) show, constructing smooth forward
price curves in electricity markets can be a tedious and
challenging exercise; however, the benefits of doing it
are the readily available medium-term price forecasts for
multiple horizons. These forecasts can be biased, though,
and include the risk premium. Care should be taken
when using them, see for example Gjolberg and Brattested
(2011), Kristiansen (2007) and Ronn and Wimschulte
(2009).
3.7.1. Jump-diffusion models
The various jump-diffusion models found in the energy
economics literature can be obtained as special cases of the
following general stochastic differential equation (SDE) for
the increment of the (deseasonalized and detrended) spot
electricity price X
t
:
dX
t
= (X
t
, t)dt + (X
t
, t)dW
t
+ dq(X
t
, t), (6)
where dW
t
are the increments of a standard Wiener
process (i.e., Brownian motion) and dq(X
t
, t) are the
increments of a pure jump process.
If the drift term is such that it forces mean reversion to
a stochastic or deterministic long-term mean at a constant
rate, then the resulting process is called a mean-reverting
jump-diffusion (MRJD). Quite often, the drift takes the
following form: (X
t
, t) = ( X
t
) (i.e., as in Eq. (5)),
but other specifications are also used. For instance, Cartea
and Figueroa (2005) use a geometric MRJD process where
(X
t
, t) = ((t) ln X
t
)X
t
and (t) is a time-dependent
mean reverting level a function of a deterministic
sinusoidal seasonality and the time-dependent volatility
(t). In one of the first publications on modeling electricity
spot prices, Kaminski (1997) utilizes Mertons jump-
diffusion model, which is a combination of a geometric
Brownian motion (GBM; i.e., with (X
t
, t) = X
t
and
(X
t
, t) = X
t
) and a jump process. Its main drawback is
that it ignores mean-reversionto the normal price regime.
If a price spike occurred, GBM would assume that the
new price level is a normal event, and would proceed
randomly via a continuous diffusion process, dW
t
, with no
consideration of prior price levels, and only a small chance
of returning tothe pre-spike level. More recently, Albanese,
Lo, and Tompaidis (2012) present a numerical algorithm
for pricing derivatives on electricity prices, and study its
rate of convergence for the case of the Merton jump-
diffusion model. However, they then use the algorithm to
calculate the prices and sensitivities of both European and
Bermudan electricity derivatives within the more realistic
jump-diffusion model of Geman and Roncoroni (2006).
For the sake of simplicity, the volatility term (X
t
, t)
is usually set to a constant. However, the empirical evi-
dence suggests that electricity prices exhibit heteroskedas-
ticity (Bhar, Colwell, & Xiao, 2013; Karakatsani & Bunn,
2010; Keles et al., 2012). To circumvent this, inspired by
the interest rate modeling literature, Janczura and Weron
(2009) utilize the square root process of Cox, Ingersoll, and
Ross (1985), while Janczura and Weron (2010) use a more
general form of the volatility term: (X
t
, t) = X
t
, with
being a scalar parameter of the model. On the other
hand, Cartea and Figueroa (2005) use a time-dependent
volatility (t) in their geometric MRJD model.
The process q(X
t
, t) is a pure jump process (typically
independent of W
t
) with a given intensity and severity,
e.g., a compound Poisson process (iek, Hrdle & Weron,
2011). For the sake of simplicity, one often sets q(X
t
, t) =
Jdq(t), where J is a normal or log-normal random variable
and dq(t) are increments of a homogeneous Poisson
process (HPP) with constant intensity . However, the
empirical data suggest that the HPP may not be the
best choice for the jump component. Price spikes are
seasonal; they typically show up in higher-price seasons,
like winter in Scandinavia and summer in the central
US. Using a non-homogeneous Poisson process (NHPP)
with a (deterministic) periodic intensity function (t)
may be more reasonable, as was suggested by Weron
(2008), for example. However, the scarcity of jumps
on the daily scale can make the identification of any
adequate periodic function problematic in some markets.
For instance, Geman and Roncoroni (2006) use a highly
convex, two-parameter periodic intensity function to
ensure that the price jump occurrences cluster around the
peak dates and rapidly fade away. However, they estimate
the parameters using only 6, 16 and 27 (for the COB,
PJM and ECAR markets, respectively) spike occurrences,
which makes the calibration results highly questionable,
especially for COB. Bhar et al. (2013) propose a jump-
diffusion model with the intensity being the sum of four
seasonal dummies. They calibrate the model to PJM prices
froma more recent period (20042009), and conclude that
the Winter and Summer intensities are almost twice as
high as those in Spring and Fall. Studying German EEX
spot prices, Seifert and Uhrig-Homburg (2007) find that
Poisson jump and Poisson spike processes (i.e., with the
bounce back effect introduced by Weron, Simonsen, &
Wilman, 2004) with constant intensities are unable to
model electricity price spike patterns correctly, and the
clustering of spikes in particular. They suggest using a
stochastic jump intensity, which provides more flexibility.
After a jump, the price is forced back to its normal
level by the mean reversion mechanism. However, a high
Fig. 8. Top panel: Two sample trajectories of the standard MRJD process, see Eq. (7), for two different speeds of mean-reversion: = 0.2 and = 1. The
remaining parameters are the same for both trajectories:

= 40, = 6, = 100, = 30, and = 0.02. Clearly, the low rate of mean reversion yields
more realistic dynamics in the base regime, but is too slowto force the price back to its normal level after a jump. On the other hand, a high speed of mean
reversion leads to unrealistic dynamics in the base regime, but a reasonable price behavior after a jump. Bottom panel: A sample trajectory of a 2-state
MRS process with independent regimes, see Eqs (10)(11), having characteristics similar to the MRJD with = 0.2, i.e., with base regime parameters
= 40, = 0.2 and = 6, Gaussian spikes with =

+ 100 and = 30, and the transition matrix defined by p

11
= 0.98 and p
22
= 0.88. Observe
that MRS models allow for consecutive spikes in a very natural way.
rate of mean reversion, such as is required to force the
price back to its normal level after a jump, would lead
to a highly overestimated value of this parameter for
prices outside the spike regime; see the top panel of
Fig. 8. To circumvent this, Escribano, Pena, and Villaplana
(2002) allow for signed jumps. However, if these follow
each other randomly, the spike shape obviously has a
very low probability of being generated. Geman and
Roncoroni (2006) suggest using mean reversion coupled
with upward and downward jumps, with the direction of
a jump being dependent on the current price level. Weron,
Bierbrauer, and Trck (2004) and Weron, Simonsen et al.
(2004) assume that a positive jump is always followed
by a negative jump of (approximately) the same size, in
order to capture the rapid decline of electricity prices
after a spike; these are referred to by Seifert and Uhrig-
Homburg (2007) as Poisson spike processes. At the
daily level, i.e., when analyzing average daily prices, this
approach is a good enough approximation for some less
spiky markets. Benth, Kallsen, and Meyer-Brandis (2007)
model the spot electricity price using a sum of non-
Gaussian OrnsteinUhlenbeck processes, each of which
reverts to the mean at a different speed, and having
pure jump processes with only positive jumps as sources
of randomness. In an empirical study utilizing German
EEX market data, Benth, Kiesel, and Nazarova (2012)
compare the factor model of Benth et al. (2007), the
MRJD of Cartea and Figueroa (2005) and the threshold
model of Geman and Roncoroni (2006), and conclude
that the mean-reversion parameters for both the MRJD
and threshold models are unable to distinguish between
spikes and the base signal, thus leading to an overly slow
mean reversion for the spikes and an overly fast mean-
reversion for the base signal. These two models try to
compensate for this by a very high volatility, meaning that
the pathwise properties of the EEX price dynamics are
not captured well. On the other hand, the factor model
captures mean-reversion very well, but does not capture
the variability of the paths appropriately.
The problem of calibrating jump-diffusion models
is related to the more general problem of estimating
the parameters of continuous-time jump processes from
discretely sampled data; refer to Cont and Tankov (2003)
for an excellent review. Of particular interest are the
estimation procedures that involve the characteristic
function: the maximum likelihood (ML) and partial
ML estimation based on a Fourier inversion of the
conditional characteristic function (CCF), and the quasi-ML
estimation based on conditional moments computed from
the derivatives of the CCF evaluated at zero (Asai, McAleer,
& Yu, 2006; Singleton, 2001).
In some cases, it is easier to work with the discrete-time
version of the SDE that governs the price dynamics. For in-
stance, the mean-reverting diffusion defined in Eq. (5) can
be discretizedas anautoregressive time series of order one,
i.e. AR(1), see Section 3.8.3. Similarly, a MRJD is equivalent
to a set of two AR(1) processes with different noise terms.
The second, jump AR(1) process is chosen with a probabil-
ity equal to the intensity of the Poisson component. How-
ever, even after discretization, the discontinuities inherent
in the jump-diffusion processes cause problems. The like-
lihood function includes an infinite sum over all possible
numbers of jump occurrences in a given time interval, and
has to be either approximated or truncated in order to al-
low for a numerical computation of ML estimates (Cont
& Tankov, 2003; Huisman, 2009). One popular approach
is to approximate the likelihood function by a mixture of
normal distributions. For instance, given a standard MRJD
model
dX
t
= ( X
t
)dt + dW
t
+ Jdq, (7)
where J N(,
2
) is a normal random variable and
dq(t) are increments of a HPP with constant intensity
, Ball and Torous (1983) suggest discretizing the process
(dt t; for simplicity let t = 1) and assuming that
is small, so that the arrival rate for two jumps within
one period (e.g., a day) is negligible. Then, the Poisson pro-
cess is approximated well by a simple binary probability
of a jump, t = , and of no jump, (1 )t = (1 ).
The MRJD model can be written as an AR(1) process, with
the mean and variance of the Gaussian noise term being
conditional on the arrival of a jump in a given time inter-
val. More explicitly,
x
t
= + (1 )x
t1
+
t,i
,
where the subscript i can be either 1 (if no jump
occurred in this time period) or 2 (if there was a
jump),
t,1
N(0,
2
) and
t,2
N(,
2
+
2
).
Then, the model can be estimated by ML, with the
likelihood function being a product of densities of a
mixture of two normals (Matlab code is available from
http://ideas.repec.org/c/boc/bocode/m429008.html).
One potentially undesirable empirical property of ML-
type methods of calibrating jump-diffusion processes is
that they tend to converge to the smallest and most
frequent jump component of the actual data, though we
would prefer to capture the lower frequency, large jump
component. Instead of following the statistically sound
maximum likelihood route, many practitioners use a
hybrid or stepwise approach (see e.g. Cartea & Figueroa,
2005; Weron, 2008). First, the jumps (spikes) are filtered
fromthe mean-reverting diffusion(for a discussion, see e.g.
Janczura et al., 2013; Ullrich, 2012), then their frequency
(intensity) can be extracted by simple counting, and
the distributional parameters describing the severity of
the jumps can be obtained by standard identification
techniques. Next, the mean-reverting jump-free diffusion
is calibrated to the filtered series. With a similar goal
in mind, Chan, Gray, and van Campen (2008) explore
a recently developed method of separating the total
variation into jump and non-jump components, and, using
quadratic variation theory, non-parametrically estimate
jump parameters for five zones of the Australian power
market. They find that, while a large proportion of the total
realized variation is attributable to the continuous part of
the price process, jumps make a significant contribution:
up to 11% of the total variation in some zones. From a
forecasting perspective, the realized variation is shown to
be highly persistent, and a modest increase in forecast
accuracy canbe attained by dividing the total variationinto
its jump and non-jump components.
3.7.2. Markov regime-switching models
One of the major weaknesses of jump-diffusion models
is that they cannot exhibit consecutive spikes at the
frequency found in market data. Also, spike clustering
can be observed on the daily time scale as well as the
hourly time scale (as can be seen in Fig. 9; for more
empirical evidence, see e.g. Christensen, Hurn, & Lindsay,
2009). In contrast, Markov regime-switching (MRS) models
allow for consecutive spikes in a very natural way. The
return of prices to the normal regime after a spike is
straightforward too, as the regime-switching mechanism
admits temporal changes in the model dynamics; see the
bottom panel in Fig. 8.
MRS models are also more versatile than the hidden
Markov models (HMM; in the strict sense, see e.g. Cappe,
Moulines, & Ryden, 2005) that are more popular in sig-
nal processing, since they allowfor temporary dependence
within the regimes, and in particular, for mean reversion.
As the latter is a characteristic feature of electricity spot
prices, it is important to have a model that captures this
phenomenon. Indeed, the base regime is typically mod-
eled by a mean-reverting diffusion model (for reviews,
see Huisman, 2009; Janczura & Weron, 2010), which is
sometimes heteroskedastic (Janczura & Weron, 2009). For
the spike regime(s), on the other hand, a number of dif-
ferent specifications have been suggested in the litera-
ture, ranging from mean-reverting diffusions (Karakatsani
& Bunn, 2008), to Gaussian (Huisman & de Jong, 2003;
Liebl, 2013), lognormal (Weron, Bierbrauer et al., 2004),
exponential (Bierbrauer, Menn, Rachev, & Trck, 2007),
heavy tailed (Bierbrauer, Trck, & Weron, 2004; Weron,
2009) and non-parametric (Eichler & Trk, 2013) ran-
dom variables, to mean-reverting diffusions with Poisson
jumps (Arvesen, Medb, Fleten, Tomasgard, & Westgaard,
2013; De Jong, 2006; Keles et al., 2012; Mari, 2008).
The idea underlying Markov regime-switching is to rep-
resent the observed stochastic behavior of a (deseasonal-
ized and detrended) spot price process X
t
by L separate
states or regimes with different underlying stochastic pro-
cesses X
t,j
, j = 1, . . . , L. The switching mechanism be-
tween the states is assumed to be an unobserved (latent)
Markov chain R
t
governed by the transition matrix P con-
taining the probabilities p
ij
= P(R
t+1
= j | R
t
= i) of
switching from regime i at time t to regime j at time t +1:
P = (p
ij
) =
_
_
_
_
p
11
p
12
. . . p
1L
p
21
p
22
. . . p
2L
.
.
.
.
.
.
.
.
.
.
.
.
p
L1
p
L2
. . . p
LL
_
_
_
_
,
with p
ii
= 1
j=i
p
ij
. (8)
Because of the Markov property, the current state R
t
at time t depends on the past only through the most
recent value R
t1
. In general, L regime models can be
considered. However, two or three regimes are typically
enough to model the dynamics of electricity spot prices
adequately (Janczura & Weron, 2010; Karakatsani & Bunn,
2010).
There are essentially two popular classes of MRS models
that are used in the energy economics literature. Both
are based on a discretized version of the mean-reverting
diffusion process defined in Eq. (5), sometimes with a
more general, heteroskedastic volatility term: (X
t
, t) =
|X
t
|
. They differ in the type of dependence between

the regimes. In the first specification, only the model
parameters change depending on the state process values,
while in the second, the individual regimes are driven by
independent processes.
Dependent regimes with the same random noise
process in all regimes (but different parameters; an
Fig. 9. Upper left panel: APX-UKaverage daily spot price over the period 19.1.200331.12.2012. Lower left panel: Spikes (identified using a regime-switching
classification, RSC) and spike-filtered prices. Right panel: Histogram of the size of spike clusters for two spike filtering methods RSC and recursive filter
on prices (RFP). In particular, out of 170 (194 for RFP) spikes identified, there was one cluster of seven spikes, one (two for RFP) cluster(s) of six spikes, and
two clusters of five spikes.
approach dating back to the seminal work of Hamilton,
1989) lead to computationally simpler models, where the
observed process X
t
is described by a parameter-switching
time series of the form:
X
t
=
R
t
+ (1
R
t
)X
t1
+
R
t
|X
t1
|
R
t
t
, (9)
sharing the same set of random innovations in the L
regimes; the
t
s are assumed to be N(0, 1)-distributed.
Sample applications of this approach include those of Bor-
dignon, Bunn, Lisi, and Nan (2013); Karakatsani and Bunn
(2008); Kosater and Mosler (2006) and Mount, Ning, and
Cai (2006).
On the other hand, independent regimes (introduced
by Huisman & de Jong, 2003) allow for a greater flexibility
and admit qualitatively different dynamics in each regime.
They seem to be a more natural choice for electricity
spot price processes, which can exhibit moderately volatile
behaviors in the base regime and very volatile behaviors
in the spike regime (because of the change in the slope
of the demand function, see Fig. 7). Such models have
been used by Arvesen et al. (2013); Bierbrauer et al. (2004,
2007); Eichler and Trk (2013); Janczura (2014); Kosater
and Mosler (2006); Liebl (2013); Mari (2008); and Weron
(2009), among others. The independent regime process X
t
is defined as:
X
t
=
_
_
X
t,1
if R
t
= 1,
.
.
.
.
.
.
X
t,L
if R
t
= L,
(10)
where at least one regime i = 1, . . . , L is given by:
X
t,i
=
i
+ (1
i
)X
t1,i
+
i
|X
t1,i
|
t,i
. (11)
The other regimes are modeled by independent and iden-
tically distributed (i.i.d.) random variables. For instance, in
the three-regime model advocated by Janczura and Weron
(2010), the second regime (R
t
= 2) represents the sudden
price spikes that are caused by unexpected supply short-
ages, andis givenby i.i.d. randomvariables fromthe shifted
log-normal distribution: log(X
t,2
q
2
) N(
2
,
2
2
), for
X
t,2
> q
2
. The same assumption that observations fromthe
spike regime should not be smaller than some threshold
is also used by Eichler and Trk (2013). The third regime
(R
t
= 3) is responsible for sudden price drops (and pos-
sibly negative prices), and is governed by the shifted in-
verse log-normal law: log(X
t,3
+ q
3
) N(
3
,
2
3
), for
X
t,3
< q
3
. The values q
i
in the above formulas can be either
optimized numerically as in Janczura and Weron (2014) or
chosen arbitrarily, e.g., let q
2
be the third quartile and q
3
the first quartile of the (deseasonalized) dataset; for many
datasets, this choice is close to the optimal values. Such
a specification of the spike and drop regime distributions
ensures that observations below (above) the third (first)
quantile will not be classified as spikes (drops). It should be
noted that, once estimated, the values q
2
and q
3
are treated
as constant parameters of the model.
The calibration of regime-switching models with an
observable state process (like Threshold AR models, see
Section 3.8.5), boils down to the problem of estimat-
ing the parameters in each regime independently. In
case of MRS models, however, the calibration process
is not straightforward, since the state process is latent
and not observable directly. We have to infer the pa-
rameters and state process values at the same time. The
most popular is probably the Expectation-Maximization
(EM) algorithm, which was first used for estimating MRS
models by Hamilton (1990), and was later refined by Kim
(1994). It is a two-step iterative procedure, reaching a lo-
cal maximum of the likelihood function. First, the con-
ditional probabilities of the process being in regime j
at time t, the so-called smoothed inferences, are com-
puted for a parameter vector . Next, new and more
exact maximum likelihood (ML) estimates of are cal-
culated using the likelihood function, weighted with the
smoothed inferences from the previous step. Note that the
introduction of independent regimes results in a signifi-
cantly increased computational burden. See Janczura and
Weron (2012) for an efficient modification of the algo-
rithm to overcome this problem (Matlab code is available
from http://ideas.repec.org/s/wuu/hscode.html). It allows
for calibration that is 100 to over 1000 times faster than
the competing approach of Huisman and de Jong (2002),
utilizing the probabilities of the last 10 observations.
Note that, as a byproduct of calibrating a MRS model
to deseasonalized and detrended data, we obtain the
conditional probabilities of the process being in a certain
regime at a given time. All prices with probabilities of
being in one of the extreme regimes which exceed a
certain threshold, say 50%, may be classified as outliers.
For instance, if we calibrate a two-state MRS with an
independent lognormal spike regime and mean-reverting
base regime dynamics (see Eq. (11)), with spike cutoff q
2
=
95%, to APX-UK average daily spot prices from the period
19.1.200331.12.2012, then we will identify 170 spikes, as
in the lower left panel of Fig. 9. The other spike-filtering
technique used in this figure the recursive filter on prices
(RFP) classifies as spikes all prices that exceed the mean
price level by three standard deviations, with the outlying
observations being removed one by one in a recursive
filter fashion (for details, see Janczura et al., 2013).
Reduced-form models are generally not expected to
forecast hourly prices accurately, but are expected to
recover the main characteristics of electricity spot prices,
typically at the daily time scale. Such models provide a
simplified, yet reasonably realistic picture of the price
dynamics, and are commonly used for derivatives pricing
and risk analysis (for reviews, see e.g. Benth et al.,
2008; Eydeland & Wolyniec, 2003). Interestingly, when it
comes to volatility or price spike forecasts, reduced-form
models have beenreported to performreasonably well, see
Section 4.1.2.
The few known attempts to use either mean-reverting
jump-diffusions (Weron & Misiorek, 2008) or Markov
regime-switching models (Misiorek et al., 2006) for
forecasting the next days hourly prices have generally
confirmed their poor performance in this context. These
results are in line with earlier reports by Bessec and
Bouabdallah (2005) and Dacco and Satchell (1999), who
question the adequacy of MRS models for forecasting in
general. On the other hand, Kosater and Mosler (2006)
reach opposite conclusions, at least for medium-term
forecasts of average daily prices from the German EEX
market. They compare parameter switching (see Eq.
(9)) and independent regime (see Eqs (10)(11)) MRS
specifications to a mean-reverting diffusion (an AR(1)
process in discrete time), and find that the regime-
switching models are slightly more accurate for 30- to 80-
day-ahead forecasts. In contrast, for UK data, Heydari and
Siddiqui (2010) find that their regime-switching model
is unlikely to capture electricity price behaviors in the
medium-term, and their non-linear model with stochastic
volatility for logarithms of electricity prices performs
better than either the linear or regime-switching models,
in terms of valuing a gas-fired power plant. Similarly, Liebl
(2013) observes a poor performance of the MRS model
proposed by Huisman and de Jong (2003) for one- to
20-day-ahead forecasts of daily EEX spot prices, relative
to three factor models (see Section 4.4). However, the
combination of MRS and vector autoregressions (as was
proposed by Lanne, Ltkepohl, & Maciejowska, 2010, in a
macroeconomic context) may potentially turn out to be a
useful approach in EPF as well.
3.8. Statistical models
Reduced-form models excel at derivatives valuation
and risk analytics. However, when forecasting day-ahead
electricity prices, the models simplicity and analytical
tractability are no longer an advantage. In fact, a models
simplicity can be a serious limitation. Historically, the
first inflow of statistical EPF techniques consisted chiefly
of statistical methods of load forecasting. By a simple
substitution of prices for loads (and possibly loads for
temperatures), the researchers were able to obtain EPF
models. As time passed, more and more contemporary
statistical, econometric or signal processing techniques
were introduced to this area.
Statistical (econometric, technical analysis) methods
forecast the current price by using a mathematical
combination of the previous prices and/or previous or
current values of exogenous factors, typically consumption
and production figures, or weather variables. The two
most important categories are additive and multiplicative
models. They differ in whether the predicted price is
the sum (additive) of a number of components or the
product (multiplicative) of a number of factors. The former
are far more popular. Note, however, that the two are
closely related: a multiplicative model for prices can be
transformed into an additive model for log-prices.
Statistical models are attractive because some physical
interpretation may be attached to their components, thus
allowing engineers and system operators to understand
their behavior. They are often criticized for their limited
ability to model the (usually) nonlinear behavior of elec-
tricity prices and related fundamental variables; however,
in practical applications, their performances are compara-
ble to those of their non-linear alternatives (discussed in
Section 3.9).
3.8.1. Similar-day and exponential smoothing methods
A very popular benchmark model in EPF is the similar-
day method. It is based on searching historical data for
days with characteristics similar to the predicted day,
and taking those historical values as forecasts of future
prices (Shahidehpour et al., 2002; Weron, 2006). Similar
characteristics may include the day of the week, day of the
year, holiday type, and weather or consumption figures.
Instead of a single similar-day price, the forecast may be
a linear combination or a regression procedure that can
include several similar days.
One of the more common implementations of the
similar-day approach, which was probably introduced to
EPF by Nogales et al. (2002) andis dubbedthe nave method,
proceeds as follows. A Monday is similar to the Monday of
the previous week, and the same rule applies for Saturdays
and Sundays. A Tuesday is similar to the previous Monday,
and the same rule applies for Wednesdays, Thursdays and
Fridays. As was argued by Conejo, Contreras et al. (2005),
Contreras et al. (2003) andNogales et al. (2002), forecasting
procedures that are not calibrated carefully fail to pass this
nave test surprisingly often.
Another relatively simple benchmark, which is very
popular in load forecasting (see e.g. Taylor, 2010) but
less popular in EPF, is exponential smoothing. It is a
pragmatic approach to forecasting, whereby the prediction
is constructed from an exponentially weighted average of
past observations:
x
t
= s
t
= x
t
+ (1 )s
t1
. (12)
Each smoothed value s
t
is the weighted average of the pre-
vious observations, where the weights decrease exponen-
tially depending on the value of parameter (0, 1).
More complex models have been developed to accommo-
date time series with seasonal and trend components. The
general idea here is that forecasts are not computed from
consecutive previous observations alone, but an indepen-
dent (smoothed) trend and seasonal component can be
added. For reviews of point and interval forecasting us-
ing exponential smoothing, we refer to Gardner (2006)
and Hyndman, Koehler, Ord, and Snyder (2008).
An interesting variant of exponential smoothing is
the so-called THETA method of Assimakopoulos and
Nikolopoulos (2000). Hyndman and Billah (2003) demon-
strate that it is equivalent to simple exponential smooth-
ing with drift, where the drift is half the value of the
slope of a linear regression fitted to the data. As such, the
THETA method provides a form of shrinkage which lim-
its the ability of the model to produce extremely inaccu-
rate forecasts. The method performed very well in the M3
forecasting competition (Makridakis &Hibon, 2000). How-
ever, it should be noted that a vast majority of the test
samples included data sampled at a monthly or lower fre-
quency. It remains an open question as to whether the
THETAmethodwouldperformwell for daily or hourly elec-
tricity prices.
Summing up, to the best of our knowledge, only one
article has used exponential smoothing as a method for
EPF (though exponential smoothing is sometimes used as
a component of a larger model, see e.g. Jonsson et al.,
2013). Cruz, Muoz, Zamora, and Espinola (2011) utilize
double seasonal exponential smoothing as a benchmark
for more sophisticated models. In their study, exponential
smoothing performs slightly better than ARIMA, and both
outperform the nave method for hourly spot prices from
the Spanish market. However, all three benchmarks are
worse than either dynamic regression models (i.e., ARX)
or a neural network. Interestingly, exponential smoothing
outperforms all other methods for hour 22.
3.8.2. Regression models
Regression is one of the most widely used statistical
techniques. The general purpose of multiple regression
is to learn more about the relationships between several
independent or predictor variables and a dependent or
criterion variable. Multiple regression is based on least
squares: the model is fitted such that the sum-of-squares
of the differences between observed and predicted values
is minimized. In its classical form, multiple regression
assumes that the relationship between variables is linear:
P
t
= BX
t
+
t
= b
1
X
(1)
t
+ + b
k
X
(k)
t
+
t
, (13)
where B is a 1 k vector of constant coefficients, X
t
is the
k 1 vector of regressors (some or all of which may be
transformed beforehand, e.g., by applying the BoxCox or
a polynomial transformation) and
t
is an error term. The
regressors are selected in-sample among the explanatory
variables considered, which are assumed to be correlated
with the electricity price P
t
. In such a standard case,
estimation can be performed using maximum likelihood
methods. A time-varying regression (TVR) model allows for
price driver effects that evolve continuously:
P
t
= B
t
X
t
+
t
= b
1,t
X
(1)
t
+ + b
k,t
X
(k)
t
+
t
, (14)
where B
t
is nowa 1k vector of time-varying coefficients.
TVR model parameters can be estimated using state space
methods and the Kalman filter (see e.g. Durbin &Koopman,
2001).
Despite the large number of alternatives, linear regres-
sion models are still among the most popular EPF ap-
proaches. However, inmost papers they are combinedwith
other, typically more sophisticated methods; various in-
teresting applications are discussed in the following para-
graphs. Moreover, it is often hard to separate regression
and autoregression approaches, as many of themare called
regression models but include lagged electricity prices as
regressors. Such models could just as well be called autore-
gressions with exogenous variables (see Section 3.8.4).
In one of the early applications of regression mod-
els, Kim, Yu, and Song (2002) utilize wavelet decom-
position coupled with multiple regression. That is, the
regression coefficients are calculated using the wavelet de-
composition detail series and the predicted demand. The
day-aheadprice forecast is thengivenby the previous days
low frequency and the predicted high frequency compo-
nents. A similar forecasting technique is applied by Conejo,
Contreras et al. (2005) to hourly PJM data. Also, Schmutz
and Elkuch (2004) use multiple regression with gas prices,
available nuclear capacity, temperatures and rainfall as re-
gressors, and a mean-reverting stochastic process for the
residuals.
Koopman, Ooms, and Carnero (2007) consider general
seasonal periodic regression models with ARIMA, ARFIMA
(also known as Fractional ARIMA or FARIMA) and GARCH
disturbances for the analysis of daily spot prices of elec-
tricity. The regressors capture yearly cycles, holiday ef-
fects, and possible interventions in the mean and variance.
The authors conclude that for the Nord Pool market (but
not for other European markets), a long memory model
with periodic coefficients is required in order to model
daily spot prices effectively. However, the models fore-
casting performances are not evaluated. Karakatsani and
Bunn (2008) build a fundamental regression model for
each of the 48 half-hourly load periods in the British mar-
ket, and compare its day-ahead forecasting performance
to those of TVR and regime-switching regression mod-
els. They conclude that models which invoke market fun-
damentals and time-varying coefficients exhibit the best
predictive performances among various alternatives. Bor-
dignon et al. (2013) use similar linear regression and TVR
models in their evaluation of different forecast combina-
tion schemes, see Section 4.3.1.
Azadeh, Moghaddam, Mahdi, and Seyedmahmoudi
(2013) propose an algorithm which switches between the
predictions of different models (neural networks, fuzzy re-
gressions and a standard regression) based on some pre-
specified rules, and use it for long-term(annual time scale)
EPF. Jonsson et al. (2013) introduce a two-step methodol-
ogy for EPF, with a focus on the impact of the predicted
systemloadandwindpower generation. The nonlinear and
nonstationary influences of these explanatory variables are
accommodated in a nonparametric and TVR model. In a
second step, an AR model and exponential smoothing are
applied to account for residual autocorrelation and sea-
sonal dynamics. Empirical day-ahead forecasting results
for the Western Danish price area of Nord Pool demon-
strate the practical benefits of accounting for these ex-
planatory variables.
3.8.3. AR-type time series models
The standard time series model that takes into ac-
count the randomnature and time correlations of the phe-
nomenonunder study is the AutoRegressive Moving Average
model. In the ARMA(p, q) model, the current value of the
price X
t
is expressed linearly in terms of its p past values
(autoregressive part), and in terms of q previous values of
the noise (moving average part):
(B)X
t
= (B)
t
. (15)
Here, B is the backward shift operator, i.e., B
h
X
t
X
th
;
(B) is a shorthand notation for (B) = 1
1
B

p
B
p
; and (B) is a shorthand notation for (B) =
1 +
1
B + +
q
B
q
, where
1
, . . . ,
p
and
1
, . . . ,
q
are the coefficients of autoregressive and moving average
polynomials, respectively. Note that some authors and
computer software packages (e.g., SAS) use a different
definition of the second polynomial: (B) = 1
1
B
q
B
q
. Finally,
t
is i.i.d. noise (or white noise) withzero mean
and finite variance, which is often denoted by WN(0,
2
).
For q = 0, we obtain the well-known AutoRegressive AR(p)
model, and for p = 0, we get the Moving Average MA(q)
model.
The ARMA modeling approach assumes that the time
series under study is (weakly) stationary. If it is not,
then a transformation of the series to the stationary
form has to be done first. One of the simplest ways to
achieve this is to perform differencing. Box and Jenkins
(1976) introduced a general model that contained both
AR and MA parts, and explicitly included differencing
in the formulation. The AutoRegressive Integrated Moving
Average (ARIMA) or Box-Jenkins model has three types of
parameters: the autoregressive parameters (
1
, . . . ,
p
),
the number of differencing passes at lag-one (d), and
the moving average parameters (
1
, . . . ,
q
). A series that
needs to be differenced d times at lag-1 and afterward
has orders p and q of the AR and MA components,
respectively, is denoted by ARIMA(p, d, q), and can be
written conveniently as:
(B)
d
X
t
= (B)
t
, (16)
where x
t
(1 B)x
t
is the lag-1 differencing operator,
which is a special case of the more general lag-h
differencing operator:
h
x
t
(1 B
h
)x
t
x
t
x
th
.
Note that ARIMA(p, 0, q) is simply an ARMA(p, q) process.
Sometimes simple differencing at lag-1, even repeated
many times, is not enough to make the series stationary.
In particular, seasonal signals of period greater than
one, like electricity loads or prices, require differencing
at longer lags. Such processes are known as seasonal
ARIMA (SARIMA) models. The general notation for the
order of a seasonal ARIMA model with both seasonal and
nonseasonal factors is ARIMA(p, d, q) (P, D, Q)
s
. The
term(p, d, q) represents the order of the nonseasonal part,
while (P, D, Q)
s
represents the order of the seasonal part.
The value of s is the number of observations in the seasonal
pattern, e.g., seven for daily series with weekly periodicity,
24 for hourly series with daily periodicity, etc. The SARIMA
model can be written compactly as:
(B)(B
s
)
d
D
s
X
t
= (B)(B
s
)
t
. (17)
Note that every SARIMA model can be transformed into an
ordinary, though long, ARMA model in the variable

X
t

D
s
X
t
. As a consequence, the estimation of ARIMA and
SARIMA model parameters is analogous to that for ARMA
processes. The latter generally consist of two steps: model
identification (using information criteria to compensate
for the effect of the improvement in fit at the cost of
model complexity), and estimation of the coefficients
(e.g., by least squares regression, recursive least squares,
maximum likelihood, or the prediction error method). The
forecasting of ARMA-type models can be conducted via the
DurbinLevinson algorithm or the innovations algorithm,
or by using the Kalman filter for models specified in state
space form. For reviews, we refer to Brockwell and Davis
(1996); Ljung (1999); Shumway and Stoffer (2006), and
the very recent open access e-book by Hyndman and
Athanasopoulos (2013).
AR-type models provide the backbone of all time
series models of electricity prices. There have been some
EPF applications of (S)AR(IMA) models, but the majority
of papers propose and use time series models with
exogenous variables (load, temperature, wind). These will
be discussed in Section 3.8.4.
Cuaresma, Hlouskova, Kossmeier, and Obersteiner
(2004) apply variants of AR(1) andgeneral ARMAprocesses
(including ARMA with jumps) to short-term EPF in the
German EEX market. They conclude that specifications in
which each hour of the day is modeled separately present
uniformly better forecasting properties than specifications
for the whole time series, and that the inclusion of sim-
ple probabilistic processes for the arrival of extreme price
events (jumps) could lead to improvements in the fore-
casting abilities of univariate models for electricity spot
prices.
In a related study, Weron and Misiorek (2005) use var-
ious autoregression schemes for modeling and forecasting
prices in the California market. They observe that an AR
model with lags of 24, 48 and 168 h, where each hour of
the day is modeled separately, performs better than the
single large (S)ARIMA specification for all hours proposed
by Contreras et al. (2003). The reduction in WMAE, see
Eq. (2), even reaches 30% for a normal, non-spiky out-of-
sample test period (first week of April 2000). Misiorek et al.
(2006) find that this simple AR model structure, when ex-
panded to include a load forecast of the systemoperator, is
a tough competitor among the AR(X)-GARCH, TAR(X) and
MRS models. ARX turns out to be the best in a relatively
calm period in the California market (April to mid-June,
2000), and second best (after TARX) in a more volatile pe-
riod (second half of 2000). Also, Jonsson et al. (2013) suc-
cessfully use a similarly simple AR model (with lags of 24,
48 and 168 h) to account for residual autocorrelation and
seasonal dynamics, and use it for short-term EPF.
Conejo, Plazas et al. (2005) propose a wavelet-ARIMA
technique, which consists of (i) decomposing the price
series using a discrete wavelet transform (DWT), (ii)
modeling the resulting detail and approximation series
using ARIMA processes to obtain 24 hourly predicted
values, and (iii) applying the inverse wavelet transform,
to yield the predicted prices for the next 24 h. The
performance of the wavelet-ARIMA technique is generally
better than that of a standard ARIMA process. In all four
weekly test samples (Spanishmarket, year 2002), the mean
weekly errors are reduced; for the winter week, the error
is reduced by 25%.
In the same spirit, Shafie-Khah, Moghaddam, and
Sheikh-El-Eslami (2011) propose a hybrid method for
forecasting day-aheadelectricity prices, inwhicha wavelet
transform provides a set of better-behaved time series,
an ARIMA model is used to generate a linear forecast,
and then a radial basis function (RBF) network (see
Section 3.9.2) is used to correct the estimation error of
the wavelet-ARIMA forecast. Following Huang, Huang, and
Wang (2005), a particle swarm optimization is used to
optimize the network structure. The results for the Spanish
market showthat the proposed hybrid method canprovide
an improvement in forecasting accuracy over a standard
ARIMA model, the wavelet-ARIMA model of Conejo, Plazas
et al. (2005), the fuzzy neural network of Amjady (2006),
and the neural network of Catalo, Mariano, Mendes,
and Ferreira (2007), and also over the mixed model
of Garcia-Martos, Rodriguez, and Sanchez (2007) in three
test periods out of four. The last of these is a set of 24 hourly
ARIMA models for weekdays (which are calibrated only to
weekday prices) and a set of 24 hourly ARIMA models for
weekends (which are calibrated to weekday and weekend
prices). Consequently, the model of Garcia-Martos et al.
(2007) may be treated as a generalization of the approach
advocated by Cuaresma et al. (2004) and Misiorek et al.
(2006), where each hour of the day is modeled by a
separate AR-type model.
In a more econometric application, Haldrup and
Nielsen (2006) observe that there seems to be a strong
support for long memory and fractional integration in
Nord Pool area prices over the period 20002003. One
possible explanation for this is the fact that a significant
amount of the electricity supply in Nord Pool is from
hydropower plants, and it is a classical empirical finding
that river flows and water reservoir levels exhibit long
memory. Consequently, Haldrup and Nielsen calibrate
seasonal ARFIMA models to Nord Pool area prices and
use them for forecasting. Lagarto, De Sousa, Martins,
and Ferro (2012) describe an interesting methodology
which combines elements of time series and multi-agent
modeling. They forecast the next days 24 hourly prices
using anARIMAmodel appliedtothe conjectural variations
(see Section 3.5.1) of the firms participating in the Spanish
power market. They find that the conjectural variations
price forecast performs better than the nave method,
and slightly better than a pure ARIMA model. Further
applications of (S)AR(IMA) models in EPF include the
studies by Amjady and Hemmati (2009); Che and Wang
(2010); Cruz et al. (2011); and Tan, Zhang, Wang, and
Xu (2010). In these papers, they are used as benchmarks
for more complicated models or hybrid constructions
involving neural networks, support vector machines or
GARCH components.
3.8.4. ARX-type time series models
The time series models discussed in Section 3.8.3
relate the signal under study to its own past, and do
not explicitly use the information contained in other
relatedtime series. However, as has already beendiscussed
extensively in Section 3.6, electricity prices are also
influenced by the present and past values of various
exogenous factors, most notably the generation capacity,
load profiles and ambient weather conditions. To capture
the relationship between prices and these fundamental
variables, time series models with eXogenous or input
variables can be used. These models do not constitute a
new class; rather, they can be viewed as generalizations
of existing classes. For instance, ARX, ARMAX, ARIMAX
and SARIMAX are generalized counterparts of AR, ARMA,
ARIMA and SARIMA, respectively. Models with input
variables are also known as transfer function, dynamic
regression, BoxTiao, intervention or interrupted time series
models. Some authors distinguish among them, while
others use the names interchangeably, thus causing a lot of
confusion in the literature (for a discussion in the context
of electricity markets, see Weron, 2006). Moreover, as
was noted in Section 3.8.2, it is often hard to distinguish
between regression and ARX-type models. If the number
of fundamental regressors is large, then they are typically
called regression models; if the autoregressive structure
is complex, then they should be classified as ARX-type
models instead.
The mechanism for including exogenous variables is
analogous for all ARMA-type models. We will nowdescribe
the ARMAXmodel without loss of generality. In this model,
the current value of the spot price X
t
is expressed linearly
interms of its past values, interms of previous values of the
noise, and, additionally, in terms of present and past values
of the exogenous variable(s). The AutoRegressive Moving
Average model with eXogenous variables V
(1)
, . . . , V
(k)
, or
ARMAX(p, q, r
1
, . . . , r
k
), can be written compactly as:
(B)X
t
= (B)
t
+
k
i=1
i
(B)V
(i)
t
, (18)
where r
i
are the orders of the exogenous factors and
i
(B)
is a shorthand notation for
i
(B) =
i
0
+
i
1
B + +
i
r
i
B
r
i
, with the
i
j
s being the corresponding coefficients.
Alternatively, the ARMAX model is often defined in a
transfer function form:
X
t
=
(B)
(B)
t
+
k
i=1
i
(B)V
(i)
t
, (19)
where

i
are the appropriate coefficient polynomials. For
(B) 1, Eq. (19) yields the dynamic regression formof the
ARX model.
Typically, the estimation of ARX models is conducted
using either least squares or instrumental variables tech-
niques. The former minimizes the sum of squares of the
right-hand side minus the left-hand side of Eq. (18), with
respect to and the
i
s ((B) 1 for the ARX model). The
latter determines and the
i
s so that the error between
the right- and left-hand sides becomes uncorrelated with
certain linear combinations of the inputs. For the calibra-
tion of ARMAX coefficients, maximum likelihood (ML) or
the prediction error method is typically used. In the latter,
the parameters of the model are chosen so that the differ-
ence between the models (predicted) output and the mea-
sured output is minimized. For Gaussian disturbances, it
coincides with ML estimation. Like ML, the prediction error
method typically involves an iterative, numerical search
for the best fit (see Ljung, 1999, and Matlabs System Iden-
tification Toolbox). Other calibration techniques have also
been proposed, such as a weighted recursive least squares
algorithm(Fan & McDonald, 1994), evolutionary program-
ming (Yang, Huang, & Huang, 1996), and particle swarm
optimization (Huang et al., 2005).
Time series models with exogenous variables have been
applied extensively to short-termEPF. Nogales et al. (2002)
utilize ARMAX and ARX models (which they call transfer
function, TF, and dynamic regression, DR, respectively)
for predicting hourly prices in California and Spain. The
two models perform comparably, with the weekly MAPE
(note that Nogales et al. call it the Mean Weekly Error,
see also Section 3.3) being just below 3% for the first week
of April 2000 in California and around 5% for the third
weeks of August and November 2000 in Spain. The results
are significantly better than for the ARIMA and ARIMA-E
(ARIMA with load as an explanatory variable, i.e., ARIMAX)
models proposed by Contreras et al. (2003). Somewhat
surprisingly, however, the TF and DR models which
utilize one common multi-parameter specification for all
hours outperformthe ARIMA-E model by more than 40%.
Both the TF and ARIMA-E models use the same variables.
This may be related to the ways in which the load data
are included in the two methods. In ARIMA-E, it is just
an explanatory variable, but in the TF specification, it is
bundled with the autoregressive part of the model. What
is even more surprising is that the performance of ARIMA
is comparable to that of ARIMA-E, even though the latter
additionally uses an important exogenous variable.
Nogales and Conejo (2006) repeat their earlier study
for 2003 PJM market data. Again, the TF model performs
better than a standard ARIMA process; however, only an
18% reduction in MAPE value is observed for the test period
(JulyAugust 2003) this time. In a related study, Conejo,
Contreras et al. (2005) compare different methods of short-
term EPF: three time series specifications (ARIMA, TF and
DR), a wavelet multivariate regression technique, and a
multilayer perceptron (MLP; see Section 3.9.2) with one
hidden layer. For a dataset comprising PJM prices from the
year 2002, the ARIMA model is worse than the time series
models with exogenous variables (more than 75% worse
for the last week of July 2002), but better than the MLP.
Instead of considering a single time series specification
for all hours, Weron and Misiorek (2005) and Misiorek
et al. (2006) use a set of 24 relatively small ARX models,
one for each hour of the day, with the CAISO day-ahead
load forecast as the exogenous variable and three dummies
for recovering the weekly seasonality. They conclude that
these models perform much better than the single large
(S)ARIMA specification for all hours proposed by Contreras
et al. (2003), and slightly worse than the TF and DR models
of Nogales et al. (2002). However, only the results for the
first week of April 2000 in the California power market
are comparable, as this is the only common test sample
used in all four papers. Moreover, the TF and DR models
are calibrated to spike preprocessed data (though the
procedure is not disclosed), while the ARX models are
calibrated to raw data. In Case Study 4.3.8, Weron (2006)
calibrates ARX models to spike preprocessed California
electricity spot prices and observes that the results
improve (and are comparable to the other models), though
only for the first two weeks of April. Later, when the prices
become more volatile, spike preprocessing turns out to be
suboptimal. This may imply that the spike preprocessed
TF and DR models are particularly good for the calm, first
week of April 2000, but not in general.
Knittel and Roberts (2005) consider various economet-
ric models for day-ahead EPF in the California market, in-
cluding mean-reverting diffusions and jump diffusions, a
seasonal ARMA process (called ARMAX), an AR-EGARCH
specification (allowing for asymmetry in heteroskedas-
ticity), and a seasonal ARMA model with the temper-
ature, squared temperature and cubed temperature as
explanatory variables. They find all temperature variables
to be highly statistically significant during the pre-crisis
period (April 1, 1998April 30, 2000); however, the price-
temperature relationshipbreaks downduring the crisis pe-
riod (May 1, 2000August 31, 2000). The weekly RMSE is
also the lowest of all models examined, though the differ-
ence from the seasonal ARMA process is small.
Zareipour, Canizares, Bhattacharya, and Thomson
(2006) evaluate the usefulness of publicly available elec-
tricity market information in forecasting the hourly On-
tario energy price (HOEP). Two forecasting horizons are
considered, 3 h and 24 h, and the forecasting performances
of transfer function (i.e., ARMAX) and dynamic regression
(i.e., ARX) models are compared with those of ARIMA mod-
els. The authors find that the publicly available information
(before the real-time) can be used to improve the HOEP
forecast accuracy to some extent, but that unusually high
or low prices remain unpredictable.
Weron and Misiorek (2008) compare the accuracies of
12 relatively parsimonious time series methods for day-
ahead EPF: AR models (using the same specification as
Misiorek et al., 2006) and their extensions spike prepro-
cessed, threshold (see Section 3.8.5) and semiparametric
autoregressions (i.e., AR models with nonparametric inno-
vations) as well as mean-reverting jump diffusions. The
methods are compared using a time series of hourly spot
prices and system-wide loads from California, and a se-
ries of hourly spot prices and air temperatures from the
Nordic market. The authors find evidence that (i) models
with the system load as the exogenous variable generally
perform better than pure price models, but that this is not
necessarily the case when the air temperature is consid-
ered as the exogenous variable; and that (ii) semiparamet-
ric models, and the smoothed nonparametric ARX (SNARX)
model in particular, generally lead to better point and in-
terval (see Section 4.2.1) forecasts than their competitors,
and also, more importantly, they have the potential to per-
form well under diverse market conditions. The motiva-
tion for using semiparametric models stems from the fact
that a nonparametric kernel density estimator will gener-
ally yield a better fit to any empirical data (the model er-
ror terms in particular) than any parametric distribution.
The semiparametric ARX models relax the normality as-
sumption needed for the maximum likelihood estimation
in the ARX model. They have the same functional form as
the considered ARX model, but the parameter estimates
are obtained froma numerical maximization of the empiri-
cal likelihood, as was suggested by Cao, Hart, and Saavedra
(2003).
Lira, Muoz, Nuez, and Cipriano (2009) evaluate the
efficiency of TakagiSugenoKang and ARMAX models
(identified by means of a Kalman filter) for day-ahead EPF
in the Colombian market. The models include exogenous
variables such as reservoir levels and load. The results
show that a segmentation of prices into three intervals,
based on load behavior, contributes to a significantly
better fit. Yan and Chowdhury (2010b) present a hybrid
mid-term (on a time frame of between one and six
months) EPF model combining both a least squares
support vector machine (LSSVM) and ARMAX models.
The model shows an improved forecasting accuracy for
PJM data compared to a forecasting model using a
single LSSVM. Cruz et al. (2011) compare the predictive
accuracies of a set of methods (SARIMA, double seasonal
exponential smoothing, dynamic regression and a feed-
forward neural network), and find evidence that their
predictive accuracies can be outperformed significantly by
taking into account the systemoperators wind generation
forecasts.
More recent applications of ARX-type time series
models include those of Kristiansen (2012), who modifies
the model of Weron and Misiorek (2008) to include
Nordic demand and Danish wind power as exogenous
variables and models prices jointly across all hours (rather
than separately for each hour of the day); Caihong and
Wenheng (2012), who present a new method for the
systemidentification of multi-input, single output ARMAX
models using the CPSO algorithm, and test it on data from
the California power market; and Bordignon et al. (2013),
who use an ARMAX(1, 1, 1) model in their evaluation of
different forecast combination schemes (see Section 4.3).
3.8.5. Threshold autoregressive models
Roughly speaking, two main classes of regime-switching
models can be distinguished: those where the regime
can be determined by an observable variable (and,
consequently, the regimes that have occurred in the past
andpresent are knownwithcertainty) andthose where the
regime is determined by an unobservable, latent variable
(i.e., the MRS models discussed in Section 3.7.2). In the
latter case, we can never be certain that a particular regime
has occurred at a particular point in time, but can only
assign or estimate probabilities of their occurrences.
The most prominent member of the first class is the
Threshold AutoRegressive (TAR) model originally proposed
by Tong and Lim (1980). It assumes that the regime is
specified by the value of an observable variable v
t
relative
to a threshold value T:
1
(B)X
t
I
(v
t
T)
+
2
(B)X
t
I
(v
t
<T)
=
t
, (20)
where
i
(B) is a shorthand notation for
i
(B) = 1
i,1
B

i,p
B
p
, i = 1, 2; B is the backward shift operator; I
()
denotes the indicator function; and X
t
is the spot electricity
price. To simplify the exposition, we have specified a
two-regime model only; however, a generalization to
multi-regime models is straightforward. The inclusion of
exogenous (fundamental) variables is also possible: AR
processes are simply replaced by ARXprocesses in Eq. (20),
leading to the TARX model.
The Self Exciting TAR (SETAR) model arises when the
threshold variable is taken as the lagged value of the price
series itself, i.e., v
t
= X
td
; see Tong (1990) for an overview
and Lucheroni (2012) for an alternative construction in
the context of electricity markets. The model may also
be modified further by allowing for a gradual transition
between the regimes, leading to the Smooth Transition AR
(STAR) model. A popular choice for the transition function
is the logistic function:
G(X
td
; , T) = [1 + exp{ (X
td
T)}]
1
,
where d is the lag and determines the smoothness of
the transition. The resulting model is known as the Logistic
STAR (LSTAR) model.
There are a few documented applications of regime-
switching TAR-type models to electricity prices. Robinson
(2000) fits an LSTAR model to prices in the England
and Wales wholesale electricity pool, and shows that its
performance is superior to that of a linear autoregressive
alternative. Stevenson (2001) calibrates AR and TAR
processes to wavelet filtered half-hourly data from the
New South Wales (Australia) market, and concludes
that the TAR specification (with v
t
being the change in
demand and T = 0) outperforms the AR alternative in
forecasting performance. Rambharat, Brockwell, and Seppi
(2005) introduce a SETAR-type model with an exogenous
variable (temperature recorded at the same time as the
maximum price of the day) and a gamma distributed
jump component. A common threshold level is used
for determining both the AR coefficients and the jump
intensities. The authors estimate the model using a Markov
chain Monte Carlo with three years of daily data from
Allegheny County, Pennsylvania, and find it to be superior
(both in-sample and out-of-sample) to a jump-diffusion
model.
Weron and Misiorek (2006) calibrate various time
series specifications, including TAR and TARX (with the
system-wide load as the exogenous variable) models,
and evaluate their predictive power in the California
market. The TAR(X) models use the price for hour 24 on
the previous day as the threshold variable v
t
, and the
threshold level is estimated for every hour in a multi-step
optimization procedure with ten equally spaced starting
points spanning the entire parameter space. During the
calm pre-crisis period, the out-of-sample forecasting
results are well below acceptable levels, and the models
even fail to outperform the nave approach. Later in the
test sample, when the regime switches are more common
and the price stays in the spiky regime for longer periods
of time, the models (TARX in particular) yield much
better forecasts. However, their performances are still
disappointing. In a related study, Misiorek et al. (2006)
expand the range of threshold variables tested, and find
that a value of v
t
that is equal to the difference between
the mean prices for yesterday and eight days ago leads to a
muchbetter forecasting performance. The resulting TAR(X)
models are comparable in point forecasting accuracy to
their respective linear specifications. Weron and Misiorek
(2008) use the same TAR(X) specifications, but for Nord
Pool data from two periods: 19981999 and 20032004.
They find that, in terms of point forecasts, the TAR(X)
models have relatively large numbers of best forecasts,
but their mean errors are (nearly) the worst in the more
regular and less spiky 19981999 period, indicating that
when they are wrong, they miss the actual spot price by a
large amount. Also, the prediction intervals (PI) are of very
poor quality for both periods.
Using logistic smooth transition regression (LSTR)
as an estimation framework, Chen and Bunn (2010)
test the proposition that electricity spot price dynamics
present a pattern of varying intra-day nonlinear functions
of its key fundamental variables. For three distinct
periods of the day (off-peak, morning peak and evening
peak), they identify quite different models. The main
transitional variables identified for regime switching at
these times are the carbon price for the off-peak, when
coal is the marginal technology, reserve margin for the
morning peak, when the load is increasing most quickly,
and market concentration for the evening peak, when
market power effects are most exercisable. In a follow-up
study, Gonzalez et al. (2012) investigate the performances
of two hybrid forecasting models for predicting the
next-day spot electricity prices on the APX-UK power
exchange: (i) a conventional hybrid approach which
combines a fundamental model, formulated with supply
stack modeling, with an econometric model using data
on price drivers, and (ii) an extended variant of this
model which includes LSTR to represent regime-switching
for periods of structural change. The out-of-sample point
forecasts of both hybrid approaches (especially of the
hybrid-LSTR) compare favorably to those of non-hybrid
SARMA, SARMAX and LSTR models. The quality of the
PIs is evaluated by comparing the nominal coverages of
the models to the true coverage (no formal tests are
performed). The LSTR model gives the best results, closely
followed by the hybrid-ARX and SARMAX models. For the
hybrid-LSTR model, the observed number of exceeding
prices is significantly higher than the theoretical number,
due to the overly narrow PIs.
3.8.6. Heteroskedasticity and GARCH-type models
The linear AR(X)-type models assume homoskedasticity,
i.e., a constant variance and covariance function. From an
empirical point of view, financial time series including
electricity spot prices exhibit various forms of non-
linear dynamics, with the crucial one being the strong
dependence of the variability of the series on its own
past. Some of the non-linearities of these series relate
to a non-constant conditional variance, and they are
characterized in general by the clustering of large shocks,
or heteroskedasticity.
The AutoRegressive Conditional Heteroskedastic (ARCH)
model of Engle (1982) was the first formal model which
successfully addressed the problem of heteroskedasticity.
In this model, the conditional variance of the time series
is represented by an autoregressive process, namely a
weighted sum of squared preceding observations. In
practical applications, the order of the calibrated model
turns out to be rather large. On the other hand, if we
let the conditional variance depend not only on the
past values of the time series, but also on a moving
average of past conditional variances, the resulting model
allows for a more parsimonious representation of the data.
The Generalized AutoRegressive Conditional Heteroskedastic
GARCH(p, q) model of Bollerslev (1986) is defined as:
X
t
=
t
t
, with
2
t
=
0
+
q
i=1
i
h
2
ti
+
p
j=1
2
tj
, (21)
where
t
are i.i.d. with zero mean and finite variance, and
the coefficients have to satisfy
i
,
j
0,
0
> 0 in order
to ensure that the conditional variance is strictly positive.
The identification and estimation of GARCH models is
performed analogously to that of (S)AR(IMA) models; ML is
the preferred algorithm. By itself, the GARCH model is not
attractive for short-termEPF; however, whencoupled with
an AR-type model, it presents an interesting alternative:
the (S)AR(IMA)-GARCH model, where the residuals of the
regression part are modeled further with a GARCHprocess.
Although electricity prices exhibit heteroskedasticity, the
general experience with GARCH-type components in
EPF models is mixed. There are cases where modeling
heteroskedasticity is advantageous, but there are at least
as many examples where such models perform poorly.
In one of the first applications of GARCH models to
electricity markets, Knittel and Roberts (2005) evaluate an
AR-EGARCH specification and find it to be superior to five
other time series models during the crisis period (May 1,
2000August 31, 2000) in California. However, during the
pre-crisis period (April 1, 1998April 30, 2000), the AR-
EGARCH process yields the worst forecasts of all models
examined. A similar result is obtained by Garcia et al.
(2005), who study ARIMA models with GARCH residuals
and conclude that ARIMA-GARCH outperforms a generic
ARIMA model, but only when high volatility and price
spikes are present.
Diongue, Guegan, and Vignal (2009) investigate condi-
tional mean and conditional variance forecasts using a dy-
namic model following a k-factor GIGARCH process, and
apply this method to the German EEX prices in the years
20002002. The forecasting performance of the model (up
to one month ahead) is compared with that of a SARIMA-
GARCH benchmark model, and the empirical evidence
shows that the proposed model outperforms the bench-
mark.
In an extensive empirical study, Karakatsani and Bunn
(2010) apply three complementary modeling approaches
in order to uncover the fundamental and behavioral
drivers of the electricity price volatility both over time
and across intra-day trading periods. They attribute the
residual volatility to regular, non-linear agent reactions
to market fundamentals (covariates of heteroskedasticity),
the adaptation of price formation due to substantial agent
learning (time-varying effects), and the transient extreme
pricing in periods of scarcity (regime-switching dynamics).
Considering a number of GARCH-type models, they find
that (i) GARCH effects diminish when each of the above
sources of volatility is accounted for, and (ii) allowing for
the time-varying responses of prices to fundamentals can
yield more precise volatility estimates than an explicit
GARCH specification.
Tan et al. (2010) use a wavelet transform to decompose
historical price series, then predict each subseries sepa-
rately using either an ARIMA-GARCH model (for the ap-
proximation series) or a GARCH model (for three detail
series). This method is examined in the Spanish and PJM
electricity markets and compared to various other meth-
ods, including the fuzzy neural network of Amjady (2006).
In a related paper, Wu and Shahidehpour (2010) present
a hybrid ARMAX-GARCH adaptive wavelet neural network
model, and test it using PJM market data. The ARMAX
model is used to catch the linear relationship between the
price return series and the explanatory variable (load); the
GARCHmodel is used to unveil the heteroskedastic charac-
ter of residuals; and the wavelet neural network is used to
present the nonlinear, nonstationary impact of load series
on electricity prices.
Gianfreda and Grossi (2012) investigate the impact of
technologies, market concentration, congestions and vol-
umes on price dynamics in the Italian power market. Im-
plementing the Reg-ARFIMA-GARCH models of Koopman
et al. (2007), they assess the forecasting performances of
selected models and show that the models perform better
when these factors are considered. In a related study, Hu-
urman, Ravazzolo, and Zhou (2012) consider GARCH-type
time-varying volatility models. They find that models aug-
mented with weather forecasts statistically outperform
specifications which ignore this information in the density
forecasting of Scandinavian day-ahead electricity prices.
Statistical methods forecast the current price by using
a mathematical combination of previous prices and/or
previous or current values of exogenous factors. The
forecasting accuracy depends not only on the numerical
efficiency of the algorithms employed, but also on the
quality of the data analyzed, and the ability to incorporate
important fundamental factors, such as historical demand,
demand and consumption forecasts, weather forecasts or
fuel prices.
Some authors classify statistical models as technical
analysis tools. Technical analysts do not attempt to
measure an assets intrinsic or fundamental value; instead,
they look at price charts for patterns and indicators that
will determine an assets future performance. While the
efficiency and usefulness of technical analysis in financial
markets is often questioned, the methods stand a better
chance in power markets, because of the seasonality
prevailing in electricity price processes during normal,
non-spiky periods.
In the presence of spikes, however, statistical methods
perform rather poorly. This is especially true for price-
only models, but models with fundamental variables do
not perform well either. While it is clear that price spikes
should be captured using an adequate stochastic model,
the literature does not agree as to whether or not these
observations have to be included in the estimation process
of statistical models. In a recent extensive simulation
study, Janczura et al. (2013) show that a better in-sample
fit can be achieved by filtering average daily prices with
some reasonable procedure for outlier detection, then
calibrating the seasonal and stochastic components of the
model to spike-filtered data. In the context of forecasting
hourly day-ahead prices, some authors also recommend
filtering out spikes before calibrating AR-type or neural
network models, see e.g. Conejo, Contreras et al. (2005),
Contreras et al. (2003), Nogales et al. (2002), Shahidehpour
et al. (2002) and Weron and Misiorek (2008).
A list of reasonable spike detection methods includes
recursive filters (Cartea & Figueroa, 2005; Weron, 2008),
variable price thresholds (Trck, Weron, & Wolff, 2007),
fixed price change thresholds (Bierbrauer et al., 2004),
regime-switching classification(RSC; Janczura et al., 2013),
andwavelet filtering (Stevenson, 2001; Weron, 2006). Only
fixed price thresholds (see e.g. Boogert & Dupont, 2008;
Fanone et al., 2013) are not recommended, because they
ignore the long-termtrend-seasonal behavior of electricity
prices. Once the spikes have been identified, they have
to be replaced by normal, less spiky values. A non-
exhaustive list of solutions includes replacing spikes with
a chosen threshold (Shahidehpour et al., 2002), the mean
of the two neighboring prices (Weron, 2008), one of the
neighboring prices (Geman & Roncoroni, 2006), or similar
day values, e.g., the median of all prices having the same
weekday andmonth(Bierbrauer et al., 2007). If a long-term
trend-seasonal component (LTSC) is estimated, Janczura
et al. (2013) suggest replacing spikes with the LTSC itself.
Doing this is like replacing the extraordinary conditions
leading to a spike with the typical or normal conditions
on that day of the week and season of the year. The
replacement of a particular spike may be interpreted as
a low marginal cost power plant replacing a very high
marginal cost power plant on the marginal cost curve on
that day, or the replacement of a day exhibiting an extreme
and unanticipated demand with a typical load profile for
that day.
3.9. Computational intelligence models
Computational intelligence (CI) is hard to define.
As Duch (2007) puts it, CI is a new buzzword that means
different things to different people. We like to think of CI
as a very diverse group of nature-inspired computational
techniques that have been developed to solve problems
which traditional methods (e.g., statistical) cannot handle
efficiently. CI combines elements of learning, evolution
and fuzziness to create approaches that are capable
of adapting to complex dynamic systems, and may be
regarded as intelligent in this sense. Some authors use
the term computational intelligence as a synonym for
artificial intelligence (AI), see e.g. Poole, Mackworth, and
Goebel (1998) and nearly the entire EPF literature. Others
see it as an offshoot of AI (Konar, 2005; Rutkowski,
2008). We identify more with the latter approach, and
use the term computational intelligence throughout the
remainder of the article. We should note that other names
for CI techniques may be encountered in the literature
as well, such as non-parametric or non-linear statistical.
However, these terms are too narrow or conflict with
other classes of methods. For instance, there are both
non-parametric (e.g., kernel density estimator) and non-
linear (e.g., threshold AR) techniques that are generally
classified as belonging to the group of statistical methods,
see Section 3.8.
Artificial neural networks, fuzzy systems, support
vector machines (SVM) and evolutionary computation
(genetic algorithms, evolutionary programming, swarm
intelligence) are unquestionably the main classes of
CI techniques. Some authors also include probabilistic
reasoning and belief networks (at the intersection with
traditional AI), artificial life techniques (at the intersection
with biochemistry), and wavelets (at the intersection
with digital signal processing). CI can also be associated
with soft computing, machine learning, data mining and
cybernetics (Madani, Correia, Rosa & Filipe, 2011; Wang &
Fu, 2005).
CI models are flexible and can handle complexity
and non-linearity. This makes them promising for short-
term predictions, and a number of authors have reported
their excellent performance in EPF. As in load forecasting,
artificial neural networks have probably received the
most attention (Aggarwal et al., 2009a,b; Weron, 2006).
Other non-parametric techniques, such as fuzzy logic,
genetic algorithms, evolutionary programming and swarm
intelligence, have also been applied, but typically in hybrid
constructions.
3.9.1. Taxonomy of neural networks
Every artificial neural network (ANN, NN) model can be
classified in terms of its architecture and learning algo-
rithm. The architecture (or topology) describes the neu-
ral connections, and the learning (or training) algorithm
provides information on how the ANN adapts its weight
for every training vector. In the EPF context, ANN models
may also be classified depending on the number of out-
put nodes. The first group includes those that have only
one output node, and are used to forecast the next hours
price (see e.g. Gonzalez, San Roque, & Garcia-Gonzalez,
2005; Mandal, Senjyu, & Funabashi, 2006), the price h
hours ahead (see e.g. Amjady, 2006; Hu et al., 2008; Ro-
driguez & Anders, 2004), the next days peak price (see
e.g. Areekul, Senju, Toyama, Chakraborty, Yona, & Urasaki,
2010), the next days average on-peak price (see e.g. Guo
& Luh, 2004; Zhang & Luh, 2005), or the next days average
baseload price (see e.g. Pao, 2006). The second, less pop-
ular, group includes those that have several output nodes
and forecast a vector of prices, typically 24 (or 48) nodes
for forecasting the next days complete price profile (see
e.g. Yamin, Shahidehpour, & Li, 2004).
Network nodes (or neurons) are arranged in a rel-
atively small number of connected layers of elements
between network inputs and outputs, see Fig. 10. The
outputs are linear or non-linear functions of the inputs.
The inputs may be the outputs of other network elements,
as well as actual network inputs. In terms of architec-
ture, ANNs may be classified into two main categories: (i)
feed-forward networks, which have no loops, and (ii) re-
current (or feedback) networks, in which loops occur be-
cause of feedback connections. The feed-forward networks
are generally preferred for forecasting, whereas recurrent
networks excel in pattern classification and categoriza-
tion (Jain, Mao, & Mohiuddin, 1996; Rutkowski, 2008).
ANN models can be used to obtain not only point
forecasts but also prediction intervals (PI, i.e., interval
forecasts). Note that many publications mistakenly refer to
PIs as confidence intervals, see De Gooijer and Hyndman
(2006), Hyndman (2013), and Section 4.2.1.There are five
main approaches to computing PIs in the ANN literature:
resampling (or bootstrapping; this is the most popular),
parameter perturbation, delta (which interprets the ANN
as a nonlinear regression model and applies asymptotic
theories for the construction of PIs), meanvariance
estimation (MVE; this estimates the variance using a
dedicated ANN) and Bayesian inference. For reviews and
discussions, see e.g. Khosravi, Nahavandi, Creighton, and
Atiya (2011) and Zhang and Luh (2005).
3.9.2. Feed-forward neural networks
The simplest network, a single-layer perceptron, con-
tains no hidden layers and is equivalent to a lin-
ear regression. The forecasts are obtained by a linear
combination of the inputs. The weights (corresponding
to the coefficients of the regression) are selected using a
learning algorithm that minimizes some cost function,
e.g., the mean squared error (Hyndman & Athanasopoulos,
2013). By adding an intermediate layer with hidden nodes,
we obtain the non-linear multi-layer perceptron (MLP). This
most common family of feed-forward networks has neu-
rons organized into layers that have unidirectional connec-
tions between them; that is, the outputs of the nodes in
one layer are inputs to the next layer. The radial basis func-
tion (RBF) network is a special class of feed-forward net-
works. It has two layers: each node in the hidden layer
employs a radial basis function (with the most common
being a Gaussian kernel, see Fig. 10) as the activation func-
tion. In contrast, the activation functions of MLP are typ-
ically piecewise linear or sigmoid. Amjady and Hemmati
(2006) note that RBF networks are effective in exploiting
local data characteristics, while MLP networks are good at
capturing global data trends.
Back-propagation, which may be regarded as a gradient
steepest descent method, is by far the most popular train-
ing algorithmfor the MLP (Zhang, Patuwo, & Hu, 1998), in-
cluding in EPF applications (Aggarwal et al., 2009a). It uses
continuously valued functions and supervised learning.
Fig. 10. A taxonomy of the network architectures that are most popular in EPF. Input nodes are denoted by filled circles, output nodes by empty circles,
and nodes in the hidden layer by empty circles with a dashed outline. The activation functions for RBF networks are radial basis functions, like a Gaussian
kernel, while MLP typically use piecewise linear or sigmoid activation functions.
The LevenbergMarquardt algorithm is the second most
popular training procedure; for sample applications in EPF,
see e.g. Catalo et al. (2007); Pindoriya, Singh, and Singh
(2008); and Rodriguez and Anders (2004). Amjady (2007)
argues that it trains a network 10100 times faster than
back-propagation. However, alternative procedures have
also been suggested. For instance, Amjady and Hemmati
(2009) propose a hybrid system in which a real-coded ge-
netic algorithm(RCGA) withanenhancedstochastic search
capability is used to train a MLP, while cross-validation,
repetitive training and archiving techniques enhance its
generalization capability. They show that the method can
provide more accurate results for the Spanish market than
a standard ARIMA model, a wavelet-ARIMA model or a
fuzzy ANN(see Section 3.9.4). Pao (2006) employs a gener-
alized delta learning rule, while Zhang and Luh (2005) use
the Kalman filter.
The most common training algorithm for the RBF
network is a two-step hybrid learning algorithm: first,
kernel positions and kernel widths are estimated using
an unsupervised clustering algorithm, then a supervised
least mean square algorithm is employed to determine
the connection weights between the hidden layer and the
output layer. This hybrid algorithm converges much faster
than the back-propagation. However, for many problems,
the RBF network often involves a larger number of hidden
units thana corresponding MLP, andthe final efficiencies of
the two ANNstructures are problem-dependent (Jain et al.,
1996; Rutkowski, 2008).
In a pre-operational training period, the weights as-
signed to neuron connections are determined by matching
historical time, weather, fuel and demand data to histor-
ical electricity prices. However, more complex construc-
tions are also used. For instance, Gareta, Romeo, and Gil
(2006) use a combination of univariate MLP networks, in
which three auxiliary networks forecast maximum, min-
imum and medium values of the price, and then this in-
formation is fed to five principal MLP networks in order to
forecast the electricity price. Hu et al. (2008) use a market
concentration index a measure of the oligopolistic struc-
ture of the power market as an input variable for a MLP,
and showthat it has a considerable impact onthe forecasts.
The MLP architecture has been used by Chen, Dong,
Meng, Xu, Wong, and Nagan (2012); Cruz et al. (2011);
Garcia-Ascanio and Mate (2010); Gareta et al. (2006);
Mandal et al. (2006); Pindoriya et al. (2008); and Yamin
et al. (2004), among others; while the less popular RBF
architecture has been used by Guo and Luh (2003); Lin,
Gow, and Tsai (2010); Pindoriya et al. (2008); and Yao,
Song, Zhang, and Cheng (2000), among others. It should
be noted, however, that the standard MLP and RBF
networks are generally used as benchmarks for other
more sophisticated techniques, or as elements of hybrid
structures. For instance, Gonzalez et al. (2005) propose a
hybrid MLP inputoutput hidden Markov model (IOHMM;
see also Section 3.7.2), in which a conditional probability
transition matrix governs the probabilities of remaining
in the same state, or switching to another. Mori and
Awata (2007) combine regression trees (for evaluating
ifthen rules and classifying input data into clusters) with
normalized RBF networks to calculate more accurate one-
step-ahead electricity price forecasts.
Keynia and Amjady (2008) use a hybrid MLP-type
model that involves wavelet decomposition, a mixed
data model that includes time- and wavelet-domain
features, a relief algorithm for feature selection, and
a MLP for forecasting and cross-validation. The new
algorithm compares favorably with three other MLP
models for PJM data. Amjady and Keynia (2009) propose
a MLP in which the numbers of hidden and input
neurons are adjusted based on an iterative procedure,
after which an evolutionary algorithm is used to make
further adjustments to the weights of the network in the
neighborhood of the weights found initially. Chabane
(2014a) models the residuals of an ARFIMA model using
a MLP with past prices as inputs (which can be treated
as a special case of the recurrent NARX network, see
Section 3.9.3). Shafie-Khah et al. (2011) construct a hybrid
wavelet-ARIMA-RBF network, in which a RBF network
corrects the estimation error of the wavelet-ARIMA
forecast. Like in Huang et al. (2005), a particle swarm
optimization is used to optimize the network structure.
Finally, Guo and Luh (2004) use a committee machine
composed of one MLP and one RBF network to alleviate the
problem of the inputoutput data misrepresentation by a
single ANN. This approach resembles combining forecasts,
which will be discussed in Section 4.3.
3.9.3. Recurrent neural networks
Feed-forward networks are classified as static in the
sense that they produce only one set of output values, not a
sequence of values froma given input. They are also mem-
oryless: their response to an input is independent of the
previous network state. On the other hand, recurrent (or
feedback) networks are dynamic systems. When a new in-
put patternis presented, the neuronoutputs are computed.
Because of the feedback, the inputs to each neuron are
modified, which leads the network to enter a new state.
Simple recurrent networks include Elman and Jordan
networks as special cases (see e.g. Jacobsson, 2005). The
Elman ANN is a three-layer network with the addition of
a set of context units. There are connections from the
hidden (middle) layer to these context units; they have
fixed weights (e.g., one) and do not have to be updated
during training. As a result, each of the neurons in the
hidden layer processes both the external input signals and
signals fromfeedback, but the signals fromthe output layer
are not subject to the feedback operation. In the Jordan
networks, the context units (also called the state layer)
are fed from the output layer instead of the hidden layer,
and have a recurrent connection to themselves. A more
general class is that of fully recurrent networks, also known
as real-time recurrent networks (RTRN). In such structures,
the outputs of all neurons are connected recurrently to
all neurons in the network. Simple and fully recurrent
networks can be trained using gradient algorithms;
however, these take a more complex form than is the case
of network learning without feedback (Rutkowski, 2008).
Sharma and Srinivasan (2013) combine a FitzHugh
Nagumo model, for mimicking the spiky price behavior,
with an Elman network, for regulating the latter, and
a feed-forward ANN, for modelling the residuals. The
hybrid model thus developed is used for point and interval
forecasting in markets in Australia, Ontario, Spain and
California. Note that the FitzHughNagumo model had
been used previously for the same purpose by Lucheroni
(2012). Anbazhagan and Kumarappan (2013) use Elman
networks to obtain short-term price forecasts in the
market of mainland Spain. They conclude that their
network performs better than a number of other EPF
approaches, including ARIMA, wavelet-ARIMA, MLP, fuzzy
ANN and wavelet-ARIMA-RBF networks. However, simple
recurrent networks are inherently weak in learning time
series with long-term dependencies using gradient based
algorithms. This forgetting behavior (Frasconi, Gori, &
Soda, 1992) is due to the so-called vanishing gradient
property, where, under certain conditions, the fraction of
the error gradient that is due to information h time steps
in the past decreases exponentially as h increases.
To overcome the vanishing gradient problem, nonlinear
autoregressive models with exogenous inputs (NARX) have
been proposed by Lin, Horne, Tino, and Giles (1996).
These recurrent networks also have very good learning
capabilities and generalization performances. A typical
NARX network is a three-layer feed-forward architecture,
with sigmoid activation functions in the hidden layer,
linear activation functions in the output layer, and delay
lines for storing previous values of the predicted time
series, x
t
, and the exogenous variables, z
t
. The output
of the NARX network, x
t
, is fed back to the input of
the network (through delays: x
t1
, . . . , x
tp
). In a way,
a NARX architecture resembles a Jordan network. At
the same time, it is also a neural network (nonlinear)
variant of the well-known ARX time series model, see
Section 3.8.4. Surprisingly, NARX networks were not used
for EPF until very recently, despite the fact that various
statistical software packages, like Matlab, offer ready-to-
use functions and user-friendly interfaces. To the best of
our knowledge, only one paper on EPF has applied an
explicit NARX architecture; see also the empirical results
discussed in Section 4.3.1. Specifically, Andalib and Atry
(2009) use a NARXmodel to forecast hourly Ontario energy
prices (HOEP), where both the lagged values of HOEP and
the lagged values of hourly demand are considered as
explanatory variables. However, a similar effect is achieved
if the inputs to a feed-forward network (e.g., a standard
MLP) are past prices. Chabane (2014a) even calls the
network he uses NAR: a nonlinear autoregressive model.
The networks reviewed thus far can be trained using
either supervised (with a teacher, with known answers)
learning for pattern classification and forecasting, or un-
supervised (without a teacher) learning for data analy-
sis and clustering. Self-organizing maps (SOM) are trained
using only the latter approach: the learning sequence is
made only of input values, without the desired output sig-
nal. One of the more popular architectures, known as Ko-
honens SOM, consists of a two-dimensional array of nodes,
each of which is connected to all input nodes. It can be used
for the projection of multivariate data, density approxima-
tion, and clustering. SOMnetworks have not been used ex-
tensively in EPF, but there are examples of applications in
hybrid structures. For instance, Fan, Mao, and Chen (2007)
and Niu, Liu, and Wu (2010) use SOM classifiers to cluster
hourly electricity price data according to their similarities
(to resolve the problem of insufficient training data), and
then employ support vector machines (see Section 3.9.5)
to predict the prices within each subset.
3.9.4. Fuzzy neural networks
Fuzzy logic is a generalization of the usual Boolean
logic, in that, instead of an input taking a value of 0 or
1, it has certain qualitative ranges associated with it. For
example, a temperature may be low, medium or high.
Fuzzy logic allows outputs to be deduced from fuzzy or
noisy inputs, and, importantly, there is no need to specify a
precise mapping of inputs to outputs. Following the logical
processing of fuzzy inputs, a defuzzification process may
be used in order to produce precise outputs (e.g., prices
for particular hours). Fuzzy neural networks (FNN) combine
the learning and computational power of traditional
ANNs with fuzzy logic (Konar, 2005; Rutkowski, 2008).
A considerable amount of research attention has been
devoted to rule generation using various FNN structures;
for reviews in soft computing, see e.g. Mitra and Hayashi
(2000) and Wang and Fu (2005).
One of the first applications of fuzzy logic to EPF was
performed by Hong and Hsiao (2002), who utilize fuzzy-
c-means for classifying historical data into three clus-
ters (peak, medium and off-peak), and then employ a
recurrent network for foreasting. Vahidinasab, Jadid, and
Kazemi (2008) take a similar approach, but use a MLP for
price forecasting. Rodriguez and Anders (2004) build an
adaptive-network-based fuzzy inference system (ANFIS),
which combines an adaptive mechanism with Sugeno-
type rules and uses a combination of the least squares
method and back-propagation for training the member-
ship function and the linear combination parameters. They
show that the ANFIS performs better than a MLP. Am-
jady (2006) proposes a FNN which has an inter-layer and
a feed-forward architecture and uses a new hypercubic
training mechanism. The method is shown to predict Span-
ish hourly day-ahead electricity prices better than ARIMA,
wavelet-ARIMA, MLP or a RBF network.
More recently, Meng, Dong, and Wong (2009) train a
RBF network using fuzzy-c-means, and differential evolu-
tion is used to auto-configure the network structure and
to obtain model parameters. Furthermore, a moving win-
dow wavelet de-noising technique is introduced so as to
improve the network performance in forecasting Queens-
land (Australia) electricity prices. Catalo, Pousinho, and
Mendes (2011) propose a hybrid approach, which com-
bines a wavelet transform, particle swarm optimization
and an adaptive-network-based fuzzy inference system.
Finally, Azadeh et al. (2013) present an integrated, multi-
step algorithm which combines three ANNs, seven fuzzy
regressions (see e.g. Gadysz &Kuchta, 2011) and one stan-
dard regression model to provide a joint framework for
long-term (annual time scale) EPF. The algorithm switches
between the predictions of the different models based on
some pre-specified rules. The results indicate that the stan-
dard and fuzzy regressions considerably outperformANNs.
3.9.5. Support vector machines
The support vector machine (SVM) is a classification
and regression tool that has its roots in Vapniks (1995)
statistical learning theory. Incontrast to ANNs, whichtry to
define complex functions of the input space, SVMperforms
a non-linear mapping of the data into a high dimensional
space, then uses simple linear functions to create linear
decision boundaries in the newspace. An attractive feature
of SVMis that it gives a single solution that is characterized
by the global minimumof the optimized functional, rather
than multiple solutions associated with local minima, as
do ANNs. Furthermore, they rely less heavily on heuristics
(i.e., an arbitrary choice of the model) and have a more
flexible structure (iek, Hrdle & Weron, 2011). SVM has
been applied widely to pattern classification problems and
non-linear regressions. After SVM classifiers have been
trained, they can be used to predict future trends. As Wang
and Fu (2005) note, the meaning of the term prediction is
different in the context of SVM. Here, prediction means
a supervised classification that involves two steps: first, a
SVM is trained as a classifier using a part of the data, then
this classifier is used to classify (predict) the rest of the
data in the data set. The classification may be improved
further by introducing individual penalty parameters for
each sample and using an AdaBoost-like algorithm in the
training phase (Zie ba, Tomczak, Lubicz, & wia tek, 2014).
The applications of SVM in electricity price forecasting
are typically those of elements inhybridsystems; however,
in one of the first papers on this topic, Sansom, Downs,
and Saha (2002) compare a MLP and a SVM with the
same inputs, and conclude that the SVM produces more
consistent forecasts and requires less time for optimal
training. Also, Zhao, Dong, Xu, and Wong (2008) employ
a SVM to forecast the value of the spot price.
Fan et al. (2007) and Niu et al. (2010) use SOM
classifiers to cluster hourly electricity price data according
to their similarity, then employ SVM to predict the
prices within each subset. Che and Wang (2010) propose
a hybrid model called SVRARIMA that combines both
support vector regression (SVR; to capture the nonlinear
patterns) and ARIMA models. The results demonstrate that
the SVRARIMA model outperforms some of the existing
ANN approaches and traditional ARIMA models. Yan and
Chowdhury (2010b) present a hybrid mid-term (on a
time frame between one and six months) EPF model
combining least-squares SVM and ARMAX models. The
model shows an improved forecasting accuracy for PJM
data compared to a forecasting model using a single
least-squares SVM. Chabane (2014b) proposes a new
hybrid model, which exploits the features of ARFIMA and
least-squares SVM, and shows that, for Nord Pool data,
it outperforms the two individual models when applied
separately.
The major strength of computational intelligence tools
is their ability to handle complexity and non-linearity.
In general, CI methods are better at modeling these
features of electricity prices than the statistical techniques
discussed in Section 3.8. At the same time, this flexibility
is also their major weakness. The ability to adapt to non-
linear, spiky behaviors may not necessarily result in better
point forecasts. This is similar to the case of Markov
regime-switching models, which have the potential to
model the highly volatile and non-linear price processes,
but have been reported to perform poorly in forecasting
in general (Bessec & Bouabdallah, 2005; Dacco & Satchell,
1999). The non-linear models have another potential
advantage, though: they should be able to provide better
interval and density forecasts than the linear models.
However, this has not been investigated extensively to
date, see Section 4.2.
Moreover, the pool of available CI tools is so diverse
and rich that it is hard to find an optimal solution. Worse
still, it is hard to compare the different CI methods thor-
oughly. Even if the forecasting accuracy is reported for the
same market andthe same out-of-sample (forecasting) test
period, the errors of the individual methods are not truly
comparable unless identical in-sample (calibration) peri-
ods are used as well, and therefore they cannot be used to
formulate general statements about a methods efficiency
unless such is the case. Instead, conclusions can only be
drawn about the performance of a given implementation
of a method, with certain initial conditions (parameters)
and for a certain calibration dataset. Although this critique
is not limited to CI techniques, it is particularly true in
their case because of their non-linearity and their multi-
parameter specifications.
4. A look into the future of electricity price forecasting
In the previous sections, we have looked back at the last
15 years of electricity price forecasting, in an attempt to
systematize the rapidly growing body of literature and the
overwhelming diversity of methods. Now, it is time to look
ahead and speculate on the directions EPF will or should
take over the next decade or so. In Sections 4.14.5, we
discuss five main topics, which have been indicated, either
explicitly or implicitly, in the preceding sections.
4.1. Fundamental price drivers and input variables
A key point in EPF is the appropriate selection of
input variables. On the one hand, the electricity price
exhibits seasonality at the daily and weekly levels, and the
annual level to some extent. In the short term, the latter
may be ignored, but the daily and weekly seasonalities
have to be taken into account. In the mid-term, the daily
profile becomes irrelevant (and most EPF models work
with average daily prices), but the annual seasonality (if
present), or a longer-term trend-cycle component, plays
a crucial role. Finally, in the long term, when the time
horizon is measured in years, the daily, weekly and even
annual seasonality may be ignored, and long-term trends
dominate.
On the other hand, as has been discussed in previ-
ous sections, the electricity spot price is dependent on a
large set of fundamental drivers, including system loads
(demand, consumption figures), weather variables (tem-
peratures, wind speed, precipitation, solar radiation), fuel
costs (oil and natural gas, and to a lesser extent coal),
reserve margin (surplus generation, i.e., available gener-
ation minus/over predicted demand), and the scheduled
maintenance or forced outages of important power grid
components. Their historical (past) values and (market or
expert) predictions for the forecasting horizon considered
are valuable for the construction and proper calibration of
the models. Care should be taken, however, as in some pe-
riods or markets their influence on the spot price may be
very limited. For instance, Maciejowska (2014) reports for
the UK market that fundamental drivers (wind generation,
demand, gas price) played a minor role, while speculative
or spot price shocks were responsible for up to 95% of the
price volatility in 2011 and 2012.
As Amjady and Hemmati (2006) observe, most papers
select a combination of these fundamental drivers, based
on the heuristics and experience of the forecaster.
The model category (multi-agent, fundamental, reduced
form, statistical or computational intelligence) and data
availability are the other important decision variables.
Although pure price models are sometimes encountered
in EPF, they are in the minority in the most common
day-ahead forecasting scenario. Thus, some input features
have to be selected, but their optimal choice remains an
open question. The development of an objective method
of selecting a minimum set of the most effective input
variables would be very valuable. We doubt, however, that
one universal set can be found for all power markets.
4.1.1. Modeling and forecasting the trend-seasonal compo-
nents
In the standard approach to seasonal decomposition,
a time series say, the electricity spot price P
t
is de-
composed into the long-term trend-seasonal component
(LTSC) T
t
, the short-term seasonal component (STSC) s
t
,
and the remaining variability, error or stochastic compo-
nent X
t
, in either an additive (i.e., P
t
= T
t
+ s
t
+ X
t
) or
a multiplicative fashion (i.e., P
t
= T
t
s
t
X
t
), see also
Section 3.8. Note that in time series analysis, a distinction
is drawn between seasonal patterns of a fixed period and
cyclic patterns that exhibit rises and falls that are not of a
fixed period (Hyndman & Athanasopoulos, 2013).
The hourly and weekly seasonality which is due
generally to the variable intensity of business activities
throughout the week is usually captured by a com-
bination of the autoregressive structure of the models
(i.e., lagged prices are input variables) and dummy vari-
ables. The forecasting of such a seasonal pattern is straight-
forward. To simplify this task even more, some studies
perform the forecasts separately across the hours, thus
eliminating the needfor explicit modeling of the daily price
profile, but leading to 24 (or 48) sets of parameters (see
e.g. Karakatsani & Bunn, 2008, 2010; Misiorek et al., 2006;
Raviv, Bouwman, & van Dijk, 2013). The rationale comes
from (i) the demand forecasting literature, which has gen-
erally favored the multi-model specificationfor short-term
predictions (Bunn, 2000; Shahidehpour et al., 2002), (ii) an
argument that each hour displays a rather distinct price
profile, reflecting the daily variation of demand, costs and
operational constraints (Karakatsani &Bunn, 2008; Weron,
2006), and (iii) the day-ahead market structure, where the
delivery of electricity during a particular hour is a different
contract from delivery in the next hour (see Section 3.1).
The weekly dummies typically do not cover the whole
week but are restricted to the more distinct days, e.g., Mon-
day, Saturday and Sunday (Weron & Misiorek, 2008) or
Monday, Friday, Saturday and Sunday (Kristiansen, 2012).
The annual seasonality is present in electricity spot
prices (due to changing weather conditions throughout the
year), but in most cases it is dominated by a more irregular
cyclic component that depends on macroeconomic vari-
ables (e.g., fuel prices, economic growth) and long-term
weather trends (e.g., lower than historical precipitation or
temperatures). In the time series literature, this would be
called a trend-cycle component; in electricity price model-
ing, it is referred to instead as a trend-seasonal component,
to reflect the underlying annual seasonality. There are es-
sentially three approaches to modeling the LTSC in elec-
tricity spot prices:
piecewise constant functions or dummies, possibly
combined with a linear trend (Fanone et al., 2013;
Fleten, Heggedal, & Siddiqui, 2011; Gianfreda & Grossi,
2012; Haugom & Ullrich, 2012; Higgs & Worthington,
2008; Knittel & Roberts, 2005);
sinusoidal functions or sums of sinusoidal functions
of different frequencies (Benth et al., 2012; Bierbrauer
et al., 2007; Cartea & Figueroa, 2005; De Jong, 2006;
Geman & Roncoroni, 2006; Seifert & Uhrig-Homburg,
2007; Weron, 2008);
wavelets (Conejo, Contreras et al., 2005; Janczura &
Weron, 2010, 2012; Schlueter, 2010; Stevenson, 2001;
Stevenson, Amaral, & Peat, 2006; Weron, 2006, 2009;
Weron, Bierbrauer et al., 2004; Weron, Simonsen et al.,
2004) or other nonparametric smoothing techniques
like Friedmans supersmoother, the HodrickPrescott
filter, spline functions, empirical mode decomposition,
and singular spectrum analysis (Bordignon et al., 2013;
Lisi & Nan, 2014; Weron & Zator, 2014b).
When building stochastic models for EPF in the mid-
term, the problem that is of the utmost importance is
the estimation and consequent forecasting of the trend-
seasonal components in the data. While the STSC is less
important for derivatives valuation and risk management
applications, the LTSC is crucial for the accuracy of the
simulation-based spot price models. A misspecification of
the LTSC can introduce biases or artificial price variability.
This may result in a bad estimate of the the mean reversion
level or of the price spike intensity and severity, and
consequently, in underestimating the risk, and even in
incurring financial losses (Janczura et al., 2013; Trck
et al., 2007). For instance, consider Nord Pool spot prices
for the evening peak hour (5 pm6 pm) over the two-
year period 1.1.201231.12.2013. If we fit a wavelet-
based LTSC (here using six levels of decomposition, S
6
,
and the Daubechies wavelet of order 12; for details, see
Nowotarski, Tomczyk, & Weron, 2013), a sine (of variable
period, amplitude and phase shift), and monthly dummies,
and subtract them from the prices (together with the
weekly dummies), we will obtain three different stochastic
components: X
(i)
t
= P
t
T
(i)
t
s
(i)
t
, where i = wavelet,
sine or monthly dummies, see Fig. 11. Next, if we
calibrate a stochastic model here, for simplicity, a
MRJD defined by Eq. (7) we will obtain different
parameters, potentially leading to significantly different
sample trajectories, as in Fig. 12. In this example, only
the wavelet-based LTSC yields a reasonable stochastic
model, withthe other twoapproaches underestimating the
mean jump size and overestimating the spike occurrence.
Apparently the jump component tries to correct for
deviations from the mean-reverting behavior of the sine
and monthly dummies-implied stochastic components.
Forecasting a piecewise constant or a sinusoidal LTSC
is straightforward, but the in-sample fit is generally poor,
yielding a sub-optimal model for the stochastic compo-
nent. On the other hand, forecasting a nonparametric sea-
sonal component is particularly troublesome, and some
authors only actually evaluate the out-of-sample predic-
tion of the stochastic part X
t
, without considering the
LTSC (see e.g. Bordignon et al., 2013). In a large simula-
tion study, Nowotarski et al. (2013) consider a battery of
over 300 models (including monthly dummies and mod-
els based on Fourier or wavelet decompositions, com-
bined with linear or exponential decay) and find that the
wavelet-based models are significantly better than the
commonly used monthly dummies and sine-based mod-
els, in terms of forecasting spot prices up to a year ahead.
This result calls into question the validity and usefulness
of stochastic models of spot electricity prices built on the
latter two types of LTSC models.
The overall impression is that the issue of seasonality
has been downplayed in the EPF literature. In our opinion,
this is a serious shortcoming, and efforts should be
made to address it properly in future research (see also
Janczura et al., 2013; Lisi & Nan, 2014; Nowotarski, Raviv,
Trck, & Weron, 2014). While aninadequate treatment of
seasonality will only lead to worse forecasts in the day-
ahead context, for longer-term predictions it may result in
a critical flaw in the constructed EPF model.
4.1.2. Spike forecasting and the reserve margin
When it comes to volatility or price spike forecasts, the
reduced-form models discussed in Section 3.7 have been
reported to perform reasonably well. For instance, Becker
et al. (2007) demonstrate that a time-varying probability
regime-switching model can help to predict price spikes
in Queensland, Australia. Chan et al. (2008) find that,
while a large proportion of the total realized spot price
variation is attributable to the continuous (base regime)
part of the price process, a modest increase in the volatility
forecast accuracy can be obtained by dividing the total
variation into its jump and non-jump components in a
jump-diffusion framework. On the other hand, Christensen
et al. (2012) take anapproachthat is orthogonal to the rest
of the EPF literature and consider the time series of price
spikes, not the time series of spot prices. They study half-
hourly data fromthe extremely spiky Australian market; it
is probable that data fromother markets wouldnot contain
enough spikes to calibrate the models. The authors treat
the time series of spikes as a discrete-time point process
andrepresent it as a nonlinear variant of the autoregressive
conditional hazard (ACH) model. They compute one-step-
ahead forecasts of the probability of a price spike for each
half hour in the forecast period (JulySeptember 2007),
and conclude that the ACHmodel performs better than the
benchmark logit model. Finally, Christensen et al. (2012)
explore the profitability of an informal trading strategy
utilizing electricity futures contracts and spike forecasts
fromthe two models. They conclude that using the futures
market as a hedge based on the forecasts of the ACH
model has the potential to provide significant returns:
more than 20% in the out-of-sample period considered
for the NSW and Victoria markets. However, transaction
Fig. 11. Nord Pool systemspot prices for the evening peak hour (5 pm6 pm) over the two-year period 1.1.201231.12.2013, together with three estimated
LTSC: wavelet-based LTSC (here using six levels of decomposition, S
6
, and the Daubechies wavelet of order 12; for details, see Nowotarski et al., 2013), a
sine (here: f (t) = 11.46 sin(1.88t + 1.60)) and monthly dummies.
Fig. 12. Sample simulated trajectories of a MRJD model fitted to the stochastic components obtained by subtracting each of the LTSC (wavelet-based,
sine, monthly dummies) from the Nord Pool spot price, see Fig. 11. Note the significant differences in the parameters of the MRJD model; for parameter
definitions, see Eq. (7). All three trajectories were obtained using the same set of random numbers.
costs are not taken into account and synthetic contracts
are priced artificially (due to the unavailability of intra-day
futures prices).
One may wonder whether spike forecasting could be
improved further by considering fundamental variables.
Indeed it could. One of the most influential fundamental
variables, especially when it comes to predicting spike oc-
currences or spot price volatility, is the reserve margin, also
called surplus generation. It relates the available capacity
(generation, supply), C
t
, to the demand (load), D
t
, at a given
moment in time t. The traditional engineering notion of
the reserve margin defines it as the difference between
the two, i.e., RM = C
t
D
t
(see e.g. Eydeland & Wolyniec,
2003; Harris, 2006). However, some authors prefer to work
with dimensionless ratios,
t
=
D
t
C
t
(Anderson & Davi-
son, 2008; Cartea, Figueroa, & Geman, 2009; Davison, An-
derson, Marcus, & Anderson, 2002; Maryniak, 2013; Mary-
niak & Weron, 2014), R
t
=
C
t
D
t
1 (Mount et al., 2006;
Zareipour et al., 2006; Zareipour, Janjani, Leung, Motamedi,
& Schellenberg, 2011), or the so-called capacity utilization
CU = 1
D
t
C
t
(Boogert & Dupont, 2008).
The reserve margin has seen some limited application
in electricity spot price modeling and forecasting. For
instance, Zareipour et al. (2006) evaluate the usefulness
of publicly available electricity market information in
forecasting the hourly Ontario energy price (HOEP), and
find that the reserve margin is a useful indicator. Anderson
and Davison (2008) and Davison et al. (2002) propose a
functional form for the relationship between the reserve
margin and the probability of a spike. Burger, Klar, Mller,
and Schindlmayr (2004) incorporate a function of the
demand to capacity (relative availability of power plants)
ratio
t
into their spot price model. Boogert and Dupont
(2008) assume that the spot price is a function of capacity
utilization (which they call reserve margin), and estimate
its empirical form for Dutch electricity prices. Mount et al.
(2006) propose a MRS model (see Section 3.7.2) where the
switching probabilities and the conditional mean of the
Fig. 13. Upper left: The number of spikes against the demand-to-capacity ratio, i.e., (t , t), for = two days, one week and two weeks in the period
1.6.200331.3.2006. Note that for = one and two weeks, most spikes are observed near = 0.93, as was reported by Cartea et al. (2009). The spikes
are identified using the approach of Cartea and Figueroa (2005). Upper right: The probability of observing a spike P(spike
CF
|) for a given in the same
period. Lower left: The probability of observing a spike P(spike
RSC
|) for a given in the more recent period 1.1.200631.12.2012. The spikes are identified
using the RSC method (see Janczura et al., 2013, and Fig. 9). Lower right: The probability of observing a spike P(spike|) for a given (t 2D, t) in the same
period. The spikes are identified using the RSC, RFP (see Fig. 9) and CF methods. Note that the dark green bars in the lower panels illustrate the same data,
only the scale is different.
spot price in each regime vary with both time and the
reserve margin.
While it is beyond doubt that the reserve margin
is a valuable explanatory variable, it remains an open
question as to how such data can be obtained and used
for forecasting. An interesting approach is taken by Cartea
et al. (2009), who work with publicly available forecasts for
the UK market (see www.bmreports.com), and consider a
variant of the demand-to-capacity ratio:
(t
1
, t
2
) =
D(t
1
, t
2
)
C(t
1
, t
2
)
, (22)
where D(t
1
, t
2
) is the National Demand Forecast (also re-
ferred to as Indicated Demand) and C(t
1
, t
2
) is the pre-
dicted Generation Capacity (also referred to as Indicated
Generation), and both are calculated at time t
1
(e.g., today)
for an upcoming period t
2
. The period t
2
may be a day or
a week, and the forecast horizon ranges from two days to
52 weeks. Although it is unlikely, the demand-to-capacity
ratio (Eq. (22)) can take values that are higher than unity
because it is based on forecasts, not actual values. Such sit-
uations have indeed occurred in the British market in the
period considered by Cartea et al., i.e., June 2003March
2006. Analyzing (t 1W, t) ratios, i.e., forecasts for week
t available one week earlier, they find that, except in a few
cases, all spikes appear when [0.908, 0.960]; see the
upper left panel in Fig. 13. This is surprising, given that
much higher values of the ratio have been observed: up to
1.097 for 2-day-ahead, 1.069 for 1-week-ahead and 1.031
for 2-week-ahead forecasts. It is as if, once the demand-to-
capacity ratio exceeds a certain, very high level, the sup-
ply (and perhaps the generation) side(s) of the market do
everything they can to prevent spikes, while for high but
not extremely high values of they are not very concerned
with the situation and make no serious attempt to prevent
them.
In follow-up studies, Maryniak (2013) and Maryniak
and Weron (2014) look at more recent data (up to
December 2012) and check how the results vary over
time and how they depend on the definition of a spike.
The dataset used in those papers, and also here, covers
the period 19.1.200331.12.2012, and consists of (i) APX-
UK average daily spot prices (see the upper left panel in
Fig. 9), (ii) National Demand Forecasts (the forecasts are
published daily for 214 days ahead, and once a week for
252 weeks ahead), and (iii) surplus forecasts (i.e., reserve
margin forecasts; 2- to 14-day-ahead forecasts published
on weekdays, and 2- to 52-week-ahead forecasts once
a week). The latter two sets were obtained from Elexon
(www.elexon.co.uk), a company that runs the British
balancing market. Since not all forecasts are available on
a daily basis, we use the most recent available value as a
proxy for that days forecast.
If we plot the number of spikes against the demand-
to-capacity ratio, i.e., (t , t), for = two days, one
week and two weeks, then we can observe that most
spikes cluster near = 0.93, which coincides with the
results of Cartea et al. (2009). The time period considered
is the same, i.e., 1.6.200331.3.2006, but the number of
spikes (i.e., 22) is larger than in their Figure 2 and Table
2 (i.e., 13). Hence, our results are not as clear-cut as theirs.
The difference stems from the fact that, while we use the
same approach (denoted by CF; see also Cartea & Figueroa,
2005) as they do in the calibration of their regime-
switching, reserve margin-dependent model, Cartea et al.
only identify as spikes in their Figure 2 and Table 2 those
prices which correspond to the peaks of the multi-day
spikes. Moreover, if we plot the empirical probability of
observing a spike P(spike
CF
|), = 0.93 no longer seems
so special, especially for = two days, see the upper right
panel in Fig. 13.
The changes that took place in 2005 have had a
substantial impact on the structure and behavior of the
British power market. In April 2005, the NETA system was
replaced by BETTA, which covered not only England and
Wales, but also Scotland. As a result of investments in
generation, the supply side has seen a further increase
in capacity in the years since, leading to a larger reserve
margin and fewer spikes. In the lower panels of Fig. 13,
we plot the empirical probabilities of observing spikes in
the more recent period 1.1.200631.12.2012. In the lower
left panel, we show the probability of observing a spike
P(spike
RSC
|) for a given , with the spikes being identified
using a regime-switching classification (RSC; see Janczura
et al., 2013, and Fig. 9). The lower right panel shows the
probability of observing a spike P(spike|) for a given
(t 2D, t), with the spikes being identified using three
methods: RSC, recursive filter on prices (RFP; see Janczura
et al., 2013, and Fig. 9), and the CF method of Cartea
and Figueroa (2005). Clearly, irrespective of the spike
identification method, the probability of a spike increases
withanincreaseddemand-to-capacity ratio, at least for the
shorter forecasting horizons ( =two days and one week).
It seems that for the two-week-ahead forecasts, there is
still ample time to take appropriate countermeasures in
the case of very high values of , so as to reduce the
probability of a spike to zero (see the lower left panel).
Interestingly, the results obtained are in line with the
industrial standard of 85% for the demand-to-capacity
ratio that warrants a safe functioning of the power
system (Anderson & Davison, 2008). The probability of
spikes (t 2D, t) is below 2% for < 85%, and well
below1% for < 82%. On the other hand, it is substantially
higher for values of above this threshold: up to 40%
for = two days and up to 60% for = one week!
This is clear indication that the reserve margin has a
huge potential for explaining the spike probability, as
was conjectured by Christensen et al. (2009). Its rare
application in EPF can be justified only by the difficulty
of obtaining good quality reserve margin data. Given that
more and more system operators are disclosing such
information nowadays, reserve margin data should be
playing a significant role in EPF in the near future.
4.2. Beyond point forecasts
According to the comprehensive review study by De
Gooijer and Hyndman (2006) on forecasting time series,
the use of predictionintervals and densities, or probabilistic
forecasting, has become much more common over the past
three decades, as practitioners have come to understand
the limitations of point forecasts. This does not seem to be
the case in EPF. The EPF Scopus query, see footnote 1, when
modified to include AND (prediction interval
OR interval forecast OR confidence
interval) yielded only 16 articles and conference
papers (out of 480 EPF publications, see Section 2.1).
Density forecasts are even less popular: the same Scopus
query modified to include AND density forecast
returned only one article. However, as Amjady and
Hemmati (2006) remark, electrical engineers are aware
that high-quality market clearing price predictionintervals
(PI) would help utilities to submit effective bids with low
risks.
4.2.1. Interval forecasts
It should be noted that, as in the general forecasting
literature, some authors use the term confidence interval
instead of prediction interval (PI). A PI is associated with
a random variable (e.g., electricity price) that is yet to
be observed, while a confidence interval is associated
with a parameter of a model, see Hyndman (2013) for
a discussion. In most forecasting applications we are
interested in PIs, i.e., intervals which contain the true
values of future observations with a specified probability,
not in confidence intervals.
When forecasting one step ahead, which is definitely
the most common setup in EPF, the standard deviation
of the forecast distribution is the same as (if there are
no parameters to be estimated, as in the nave method,
see Sections 3.3 and 3.8.1), or slightly larger than (be-
cause of the uncertainty associated with model selec-
tion and parameter estimation), the residual standard
deviation, see Hyndman and Athanasopoulos (2013). This
difference is often ignored, including in multi-step-ahead
forecasts, meaning that many model-based PIs are too nar-
row. One way to address this problem is to use bootstrap-
ping, see e.g. Cao (1999) and De Gooijer and Hyndman
(2006). See also Hansen (2006), who constructs asymptotic
forecast intervals that incorporate the uncertainty due to
parameter estimation, by incorporating a simple propor-
tional adjustment of the interval endpoints which depends
on the asymptotic variance of the interval estimates.
In one of the first publications on interval EPF, Zhang,
Luh, and Kasiviswanathan (2003) develop an algorithmfor
obtaining the PIs (which they call confidence intervals)
from a cascaded ANN model by using the Quasi-Newton
method. In a follow-up paper, Zhang and Luh (2005)
present a modified U-D factorization method within
the decoupled extended Kalman filter framework. The
computational speed and numerical stability of this
method are improved significantly relative to the earlier
method. The new method also provides smaller PIs.
Misiorek et al. (2006) compare the accuracies of seven
relatively parsimonious time series methods for day-
ahead EPF (see also Section 3.8.5), and evaluate their
performances in terms of one-step-ahead point (for all
models) and interval (for four models) forecasts. The latter
(called confidence intervals) are determined analytically
as quantiles of the error termdensity (for ARX, ARX-GARCH
and TARX models), or using Monte Carlo simulations (for
the MRS model). Misiorek et al. evaluate the quality of
the PIs by comparing the nominal coverages of the models
to the true coverage, and conclude that TARX models
outperform their competitors in both point and interval
forecasting.
In a follow-up study, Weron and Misiorek (2008) com-
pare the accuracies of 12 time series models (for a discus-
sion, see Section 3.8.4), and evaluate their performances in
terms of one-step-ahead point and interval forecasts. Two
types of PIs are computed: distribution-based and empiri-
cal. The method of calculating empirical PIs resembles the
estimation of the Value-at-Risk via historical simulation,
and consists of computing sample quantiles of the empir-
ical distribution of the one-step-ahead prediction errors.
The distribution-based PIs are computed as quantiles of
the error term density: Gaussian for AR-type models and
kernel estimator-implied for the semiparametric models.
Then, Weron and Misiorek use the conditional coverage
test of Christoffersen (1998) to evaluate the quality of the
PIs, andfindthat the semiparametric models, andSNARXin
particular, generally lead to better interval forecasts than
their competitors, and also, more importantly, have the po-
tential to perform well under diverse market conditions.
Zhao et al. (2008) propose a data mining-based
approach in order to achieve two major objectives: to
forecast the electricity spot price and to estimate the
respective PIs. In the proposed approach, a support vector
machine (SVM) is employed to forecast the value of the
spot price. To forecast the PIs, the authors construct a
statistical model by introducing a heteroskedastic variance
equation to the SVM. Their empirical results show that the
proposed method is highly effective relative to existing
methods such as GARCH models.
Serinaldi (2011) introduces the class of Generalized
Additive Models for Location, Scale and Shape (GAMLSS)
for forecasting the dynamically varying distribution of
electricity prices. The PIs (called confidence intervals)
are obtained as the time-varying quantiles of the density
forecasts. Like in Misiorek et al. (2006), the accuracy of the
PIs is checked by comparing the nominal coverage with the
actual one. Somewhat surprisingly, the density forecasts
themselves are not analyzed.
Garcia-Martos et al. (2011) construct PIs based on one-
day-ahead forecasts of the common volatility factors in the
proposed GARCH-SeaDFA factor model, but do not either
evaluate or test their efficiency. Also in a multivariate
context, Wu, Chan, Tsui, and Hou (2013) propose a
recursive dynamic factor analysis (RDFA) algorithm, where
the principal components (PC) are tracked recursively
using a subspace tracking algorithm, while the PC scores
are tracked further and predicted recursively via the
Kalman filter. From the latter, the covariance, and hence
the interval, of the predicted electricity price is estimated.
The accuracy of the PIs is checked by comparing the
nominal coverage with the actual one (called calibration
bias here and by computing the interval score (also
known as the Winkler score, see Gneiting &Raftery, 2007;
Maciejowska, Nowotarski, &Weron, 2014; Winkler, 1972),
whichfavors narrowPIs andpenalizes observations that do
not lie within the PIs according to the nominal proportions.
Gonzalez et al. (2012) investigate the performances of
two hybrid forecasting models for predicting the next-
day spot electricity prices in the APX-UK power exchange:
(i) a hybrid approach which combines a fundamental
model, formulated using supply stack modeling, with an
econometric model using data on price drivers, and (ii)
an extended variant of this model which includes logistic
smooth transition regression (LSTR) to represent regime-
switching for periods of structural change. The out-of-
sample point forecasts of the two hybrid approaches (and
of the hybrid-LSTR in particular) compare favorably to
those of non-hybrid SARMA, SARMAX and LSTR models.
The quality of the PIs is evaluated by comparing the
nominal coverage of the models to the true coverage
(no formal tests are performed). The LSTR model gives
the best results, followed closely by the hybrid-ARX and
SARMAX models. For the hybrid-LSTR model, the number
of exceeding prices observed is significantly higher than
the theoretical number, due to the overly narrow PIs.
Chen et al. (2012) combine an extreme learning
machine (ELM; a learning algorithm for a single hidden
layer MLP which can overcome the problems caused by
gradient descent type methods) with a wild (or external)
bootstrap approach, and use them to compute point
and interval forecasts of half-hourly spot prices in the
Australian electricity market. The uncertainty of data noise
is not considered in the construction of the PIs, and the
accuracy of the PIs is only checked by comparing the
nominal coverage with the actual one. In a follow-up
paper, Wan, Xu, Wang, Dong, and Wong (2014) first use
ELMto obtainpoint forecasts of half-hourly Australianspot
prices. Then, to compute PIs, they use a complex though
over 100 times faster than a traditional bootstrap-based
ANN approach procedure involving N + 1 additional
neural networks. They (i) construct N = 100 bootstrapped
samples from the residuals of the point forecasts, (ii)
calibrate N new MLPs (using ELM), and (iii) use MLE to
train yet another MLP for the residuals noise variance
approximation. This time, the PI accuracy is evaluated
based on both the nominal coverage (called reliability)
and the PI width (called sharpness), by computing the
interval score.
Khosravi, Nahavandi, and Creighton (2013) propose a
hybrid method for the construction of PIs, which uses
moving block bootstrapped neural networks and GARCH
models for forecasting electricity prices. Rather than
employing the traditional ML estimation, the parameters
of the GARCH model are adjusted via the minimization
of a PI-based cost function. The method is tested on
hourly electricity prices from Australian and New York
markets. The authors claim that the proposed method
generates narrow PIs with a large coverage probability.
However, the accuracy measure they use the so-
called Coverage Width-based Criterion (CWC) possesses
serious flaws and as Pinson and Tastu (2014) argue should
be avoided in PI evaluation. Khosravi et al. (2013) also
do not conduct formal statistical tests for coverage. In
fact, except for Weron and Misiorek (2008), none of
the papers discussed in this Section perform such tests.
There is certainly a need for the techniques reviewed in
Section 4.5.2 to be introduced to the EPF literature.
4.2.2. Density forecasts
Obviously, it is more useful for a modeler to know the
entire forecast density than a single PI. However, this is,
or at least seems to be, a more difficult task. For a com-
prehensive reviewof the computation of density forecasts,
we refer to Tay and Wallis (2000). This topic has barely
been touched upon in the EPF literature. As was mentioned
above, Serinaldi (2011) forecasts the distribution of elec-
tricity prices using the GAMLSS approach, but computes
and discusses only the PIs (obtained as quantiles of the
density forecasts).
Huurman et al. (2012) consider GARCH-type time-
varying volatility models, and find that models that are
augmented with weather forecasts statistically outper-
form specifications which ignore this information in the
density forecasting of Scandinavian day-ahead electricity
prices. Like Diebold, Gunther, and Tay (1998), they utilize
the probability integral transform (PIT) scores of the real-
ization of the variable with respect to the forecast den-
sities, and use the Berkowitz (2001) likelihood ratio test
for the zero mean, unit variance and independence of the
PIT scores to infer the goodness-of-fit. Huurman et al. also
measure the relative predictive accuracy by applying the
KullbackLeibler Information Criterion (KLIC; see Bao, Lee,
& Saltoglu, 2007).
In a recent paper, Jonsson, Pinson, Madsen, and
Nielsen (2014) develop a semi-parametric methodology
for generating prediction densities of day-ahead electricity
prices in Western Denmark (Nord Pool), comprising a
time-adaptive quantile regression model for the 5%95%
quantiles and a description of the distribution tails by
exponential distribution. They evaluate the quality of the
forecasts by computing the average Continuous Ranked
Probability Score (CRPS) and the related Continuous
Ranked Probability Skill Score (CRPSS). Jonsson et al. do not
perform formal statistical tests, but Gneiting, Balabdaoui,
and Raftery (2007) argue that the null hypothesis of no
difference in predictive performances can be tested easily,
given the CRPS values.
4.2.3. Threshold forecasting
Before we conclude Section 4.2, let us mention a
recent approach to EPF that is not yet well known in the
literature, but may become popular in the near future,
especially in industry. On the one hand, it may be treated
as a generalization of spike occurrence forecasting (see
Section 4.1.2), where the number of regimes is more
than two, as in a three-state (or more) MRS model (see
Section 3.7.2). On the other hand, it could be considered
as interval forecasting where, instead of constructing a PI
around a point forecast, a future price is allocated to one of
a fewprespecifiedprice intervals spanning the entire range
of attainable prices. The rationale for threshold forecasting
comes from the fact that applications like demand-side
management do not require exact values of future spot
prices, but instead use specific price thresholds as the basis
for making scheduling decisions. For instance, an industrial
consumer may decide to shut down a production line if
prices exceed a certain threshold.
To the best of our knowledge, the first paper to utilize
this approach was that of Zareipour et al. (2011). The
authors use two SVM-based models to classify future
electricity prices in the Ontario and Alberta markets with
respect to prespecified price thresholds. For both markets,
the prices are classified into three groups: (i) from the
price floor (defined by the applicable market rules in
Ontario and Alberta: 2000 and 0 respectively) to the
average price in the year 2008 (50 and 90 respectively),
(ii) from the average price to twice the average price,
and (iii) from twice the average price to the price cap
(2000 and 1000 respectively). The authors find that the
proposed models provide significantly (not in a statistical
sense, as no formal testing is conducted) more accurate
results than the three price forecasting models (ARIMA,
ARX, ARMAX) used by Zareipour et al. (2006), a mixed
similar-day and ANN predictor, or the pre-dispatch price
forecasts published by the ISO (available for Ontario only).
Interestingly, they show that the demand is not as useful
for price classification as for price forecasting, though it
leads to a slightly better classification on average. Hence, in
a follow-uppaper, Huang, Zareipour, Rosehart, andAmjady
(2012) limit the initial feature (input) set to lagged prices,
and concentrate on finding a better classifier than SVM.
Threshold forecasting seems to be particularly impor-
tant for volatile markets, where using the predicted prices
(e.g., those obtained from time series or computational in-
telligence models) is likely to lead to a worse classification.
However, it should be noted that there is a cost associ-
atedwiththe higher classificationaccuracy attainedwithin
threshold forecasting, namely the loss of exact price val-
ues, which are obviously available in classical EPF. Mixing
the two approaches may not be the best idea, as they can
lead to contradictory forecasts.
Finally, note that threshold forecasting is somewhat
related to the concept of the critical load level, see Bo and
Li (2009). The authors look at LMPs from the system level
perspective and focus on the phenomenon of the step-wise
price variation as the load increases, i.e., they consider,
not prespecified price intervals, but a set of discrete price
levels. Under a certain assumed probability distribution of
the actual load, they propose toconsider probabilistic LMPs
andformulate the probability mass functionof this random
variable. Although the approach is illustrated only for test
networks (a modified PJM five-bus system and the IEEE
118-bus system), their concept is general, and may be used
for analyzing the integration of renewables into todays
electricity markets and demand response activities.
4.3. Combining forecasts
The idea of combining forecasts goes back to the late
1960s and the seminal papers of Bates and Granger (1969)
and Crane and Crotty (1967). Since then, many authors
have suggested the superiority of forecast combinations
(also referred to as combining forecasts, forecast averaging
or model averaging) over the use of individual models, see
e.g. Clemen (1989); de Menezes, Bunn, and Taylor (2000);
Timmermann (2006); and Wallis (2011); and references
therein. Given the abundance of averaging schemes, Hibon
and Evgeniou (2005) propose a criterion for selecting
among forecasts, and show that the accuracy of the
selected combinations is significantly better than those
of the selected individual forecasts using this criterion,
and that the selected combinations are less variable. They
also make the important comment that the advantage
of combining is not that the best possible combinations
perform better than the best possible individual forecasts
(i.e., ex-post), but that it is less risky inpractice to combine
forecasts than to select an individual forecasting method
(i.e., ex-ante).
Despite this popularity, the combination of forecasts
has not been discussed extensively in the context of
electricity markets to date. There is some limited evidence
on the adequacy of combining forecasts of electricity
demand (dating back to the 1980s, see Bunn, 1985a;
Bunn & Farmer, 1985; Smith, 1989; Taylor, 2010; Taylor &
Majithia, 2000) or transmission congestion (Lland et al.,
2012); however, apart from the unpublished Ph.D. thesis
of Nan (2009), it was only very recently that Bordignon
et al. (2013); Maciejowska et al. (2014); Nowotarski et al.
(2014); Nowotarski and Weron (2014a,b) and Raviv et al.
(2013) provided empirical support for the benefits of
combining forecasts in obtaining better predictions of
electricity spot prices.
We should mention here that combining forecasts is
related to the concept of committee machines (Haykin,
1998), which is also referred to as ensemble averaging. A
committee machine is composedof multiple networks. The
individual ANNs are trained, perform predictions and then
are updated in such a way as if they were stand-alone (
individual forecasts). Then, a weight calculator generates
weighting coefficients by which individual predictions are
combined linearly in a combiner neuron ( combined
forecast). To the best of our knowledge, only Guo and Luh
(2004) use committee machines for EPF. They combine
a RBF network, which uses 23 inputs and six clusters,
and a MLP, which uses 55 inputs and eight hidden
neurons, to compute daily average on-peak electricity
prices for New England. They consider three committee
machines: (i) one withsimple arithmetic averaging, (ii) one
where the correlation matrix used to determine weighting
coefficients is re-calculated whenever new prediction
errors become available, and (iii) one newly developed
combiner. Interestingly, this promising approach involving
committee machines has not been used in more recent
publications. What is even more surprising is that the
two approaches forecast combinations and committee
machines seem to be evolving independently, with
researchers from the two groups being unaware of the
parallel developments.
4.3.1. Point forecasts
Numerous combining methods have been proposed
in the literature. Among them, simple averaging (i.e., the
arithmetic mean of individual forecasts) stands out as
the most popular and surprisingly robust approach (Bunn,
1985b; Clemen, 1989; Genre, Kenny, Meyler, & Tim-
mermann, 2013; Stock & Watson, 2004). Ordinary Least
Squares regression or OLS averaging is another easy-
to-implement approach. The idea was first described
by Crane and Crotty (1967), but it was the influential pa-
per of Granger and Ramanathan (1984) that inspired fur-
ther research efforts in this direction. In OLS averaging, the
combined forecast is determined using the following re-
gression:
P
t
= w
0t
+
M
i=1
w
it
P
it
+ e
t
, (23)
where P
t
is the actual electricity spot price at time t,
P
1t
, . . . ,
P
Mt
are the M individual price forecasts calculated
for time t, and w
it
is the weight assigned to forecast i
at time t. This approach has the advantage of generating
unbiased combined forecasts without the need to worry
about the bias of the individual models. However, the
OLS estimates of the weights are inefficient, due to the
possible presence of serial correlation in the combined
forecast errors. The vector of estimated weights w
t
is
likely to exhibit an unstable behavior, a problem that
has sometimes been dubbed bouncing betas. As a result,
minor fluctuations in the sample can cause major shifts of
the weight vector. And electricity spot prices definitely are
volatile!
To address this issue, Aksu and Gunter (1992) consider
variants of OLS averaging witheither non-negative weights
(Nonnegativity Restricted Least Squares, NRLS) or weights
that are restricted to sum to unity (Equality Restricted
Least Squares, ERLS). They find that NRLS and simple
averaging almost always outperform ERLS, which
without a constant term on average produces more
accurate forecasts than OLS averaging. Raviv et al. (2013)
combine the two restrictions to yield CLS averaging,
i.e., constrained least squares, with positive weights that
sum to unity. An alternative variant of OLS averaging that
is more robust to outliers is proposed by Nowotarski et al.
(2014). They apply the absolute loss function instead of
the quadratic one in Eq. (23), to yield the Least Absolute
Deviation regression or LAD averaging. This method may
be viewed as a special case of quantile regression, with the
quantile being equal to 0.5 (Koenker, 2005).
To illustrate the power of combining forecasts, let
us consider the hourly electricity prices from the Nord
Pool market over the period 8.8.201231.12.2013; see
the upper panel in Fig. 14. The period 8.8.20127.5.2013
(273 days = 39 weeks) is used only for the calibration
of the individual models, and hence, the first forecast is
made for the 24 h of 8.5.2013. Six pure-price models
are considered: AR, TAR, SNAR, MRJD (all four models
as in Weron & Misiorek, 2008), NAR (i.e., a recurrent
network with the same inputs as the first three models,
estimated using the LevenbergMarquardt algorithm; see
also Section 3.9.3), and a multivariate three-factor model
(FM; see Eqs (25)(26) and the description in Section 4.4).
Like in Weron and Misiorek (2008), the calibration window
is expanded by one day after the 24 hourly forecasts have
been made for the next day. Three combining schemes
are used, namely simple, CLS and LAD averaging, and
calibrated on a rolling window of 28 days (which turned
out to yield better combined forecasts than an expanding
window). The first forecast of the averaging models is
made for the 24 h of 5.6.2013. All models are evaluated
in terms of the WMAE, see Eq. (2), in the 30-week
period 5.6.201331.12.2013. The results are illustrated in
the lower panel of Fig. 14 and summarized in Table 1.
Clearly, combining is advantageous. The simple and CLS
averaging lead to forecasts that are the best on average
(in terms of WMAE) and most often overall (out of those
obtained from the nine individual and combined models),
and that deviate the least from the best possible forecast
(in terms of WMAE). In particular, CLS averaging stands
out as the optimal approach, yielding the lowest WMAE
and m.d.f.b. statistics, see Table 1. It is also the only
averaging approach that is able to provide a reasonable
forecast (WMAE = 10.48) in the most spiky third week
of the test period, only slightly worse than the best-
performing model in this week, the recurrent network
model (WMAE = 9.21). Apart from LAD (WMAE = 13.65),
all other models yield extremely large errors, ranging from
17.25 (Simple) to 21.14 (TAR).
Fig. 14. Top panel: NordPool hourly systemspot price inthe period8.8.201231.12.2013. The out-of-sample 30-week test periodis indicatedby a rectangle,
while the vertical dotted line represents the beginning of the individual models forecasts and the calibration window for the forecast averaging methods
(four weeks prior to the test period). Bottom panel: A plot illustrating the deviation of a particular models WMAE, see Eq. (2), with respect to the WMAE of
the best model in week i, i.e., WMAE
i
min(WMAE
i
). All values exceeding three are set to three.
Table 1
Summary statistics for the six individual and three averaging methods.
Individual models Forecast combinations
AR TAR SNAR MRJD NAR FM Simple CLS LAD
WMAE 5.03 5.07 4.77 4.98 4.88 5.36 4.47 4.29 4.92
(3.40) (3.53) (3.26) (3.17) (1.62) (3.17) (2.87) (1.88) (2.41)
# best 1 3 4 1 2 4 8 6 1
m.d.f.b. 1.01 1.05 0.75 0.96 0.86 1.34 0.45 0.27 0.89
Notes: WMAE is the mean value of WMAE for a given model (with standard deviation in parentheses), # best is the number of weeks in which a given
averaging method performs best in terms of WMAE, and finally m.d.f.b. is the mean deviation from the best model in each week. The best values in each
row are emphasized in bold. The out-of-sample test period covers 30 weeks (5.6.201331.12.2013).
As the literature on combining forecasts is now
voluminous and rather repetitive (Wallis, 2011), we do
not attempt to review all or even most methods. Instead,
we only mention briefly three other approaches that have
been applied in EPF. One is to choose the weights for each
model based on the inverse of the Root Mean Squared
Errors (IRMSE). Clearly, models that produce smaller errors
will be assigned larger weights than models with higher
errors, an approach dating back to Bates and Granger
(1969), and later adopted by Diebold and Pauly (1987),
Stock and Watson (2004) and Timmermann (2006), among
others. Interestingly, for two different sets of individual
models, Nowotarski et al. (2014) and Raviv et al. (2013)
observe that, in the case of electricity prices, IRMSE
averaging leads to nearly the same predictions as simple
averaging. This is due to the fact that the RMSE errors
of the individual models tend to be large compared to
the differences between them. Hence, the IRMSE weights
are different from each other but very close to the equal
weights of simple averaging. A potential remedy would be
to subtract a certain value, say half of the lowest RMSE
value, from the errors, and then apply the algorithm.
The second approach is to use adaptive weights. In the
simplest case, any of the models discussed so far can be
reestimated at every time step (using either an expand-
ing or a rolling window), meaning that the weights would
become adaptive. A more sophisticated adaptive approach
is, for instance, Aggregated Forecast Through Exponen-
tial Re-weighting (AFTER; see Sanchez, 2008; Zou & Yang,
2004). Finally, the third approach is to use Bayesian Model
Averaging (BMA) to avoid the a priori decision to use all
models (Madigan & Raftery, 1994); see also Geweke and
Amisano (2010); Geweke and Whiteman (2006); Hooger-
heide, Kleijn, Ravazzolo, Van Dijk, and Verbeek (2010);
and Koop and Potter (2004) for more recent variants
and applications. The model weights for BMA are given
by Bayes theorem, according to which we compute the
posterior probabilities for each of the possible individual
model combination options m
l
, l = 1, . . . , 2
M
, not the M
individual models. Once the weights are set, the condi-
tional expectation of the forecast is calculated for each of
the options considered, and the resulting forecast com-
bination is given by
P
c
t
=

2
M
l=1
w
lt
E(P
t
|m
l
,
l
), where
l
is the collection of parameters required for combi-
nation option l (R code is available from http://cran.r-
project.org/web/packages/BMA).
In the first paper in EPF to consider forecast averaging
explicitly, Nan (2009) evaluates three averaging schemes
(simple and two variants of IRMSE-type averaging) on a
dataset comprising 20052006 British day-ahead electric-
ity prices for four half-hourly loadperiods. The author finds
that combinations only work better during the Spring sea-
son for load period six, which is a very calm period, and
argues that the reason for such a disappointing perfor-
mance is that the 19 individual models introduce too much
variation in the combinations, as some models perform
very poorly during particular seasons and/or for particu-
lar hours. Nan (2009) then applies the model confidence
set (MCS) and forecast encompassing techniques (see Sec-
tion 4.5.2) to select subsets of two to four models for com-
bining, which differ for each season and each load pe-
riod, and is able to outperform the individual predictors
in most cases. Interestingly, Nowotarski et al. (2014) do
not confirm the need to select subsets of individual mod-
els for combining, and argue that the problemfaced by Nan
(2009) is due, not to an overabundance of individual mod-
els, but to their similarity they are all variants of four
base specifications: ARMAX, linear regression, TVR and a
MRS model.
This is confirmed to some extent by the approach
taken in a follow-up article by Bordignon et al. (2013),
who combine forecasts obtained from only five individual
models (the fifth is a variant of the MRS model estimated
on a rolling window of six months, not an expanding one).
Five combining methods are considered, including simple,
IRMSE-type and AFTER averaging. The authors examine
whether forecast combinations outperform individual
methods, from both an ex-post (i.e., using full sample
information) and an ex-ante (i.e., using only information
available at the time the forecast is made) perspective.
In the more realistic ex-ante perspective, they find
that combined forecasts perform better than individual
forecasts, with the difference being significant in 33% of
cases (they apply the DM test, see Section 4.5.2, and
consider five half-hourly load periods). On the other hand,
the individual forecasts are significantly less accurate than
the combined forecasts in only 1% of cases.
Raviv et al. (2013) model the hourly prices by con-
sidering the intra-day relationships between the indi-
vidual hours in the Nord Pool spot market. For the
univariate analysis, they use heterogeneous autoregres-
sive (HAR) and dynamic ARX models. For the multivariate
analysis, they use VAR-type, Bayesian VAR, reduced rank
regression (RRR), principal component regression and re-
duced rank Bayesian VAR models. The authors focus is
not on investigating the usefulness of averaging forecasts,
but their empirical application finds that additional gains
are achieved by using forecast combinations of individual
models: even the best individual model is outperformed by
forecast averaging (though not by a huge margin).
In an extensive empirical study, involving the 12
individual models used by Weron and Misiorek (2008),
four datasets from three major European and North
American markets, and seven averaging schemes (simple,
OLS, NRLS, CLS, LAD, IRMSE, BMA), Nowotarski et al.
(2014) find that the performances are not uniform
across the markets considered. While their findings also
show the additional benefits of combining forecasts for
deriving more accurate predictions ex-ante, they are
not as clear-cut as those of Bordignon et al. (2013).
The authors find that four forecast averaging methods
out of seven (namely simple averaging, NRLS, CLS and
IRMSE) clearly outperform the benchmark ARX model
and the best individual (BI) ex-ante scheme (a selection
scheme which picks one of the models that performed
best in the past). However, one of the four, NRLS, is
outperformed significantly (with respect to the DM test)
by the benchmark ARX model and the BI selection scheme
roughly as often as it outperforms them. Nowotarski
et al. also remark that methods like OLS, NRLS and BMA,
which allow for unconstrained weights, perform poorly
and should be avoided in EPF. On the other hand, they
recommend CLS averaging as a choice which may not
be optimal, but will not worsen the prediction accuracy
significantly compared to the BI ex-ante model; note that
CLS averaging is also best in Table 1. Finally, Nowotarski
et al. (2014) find that, while simple averaging and IRMSE
are significantly more accurate than the benchmark ARX
model in 50% of cases, and significantly less accurate
in only 1% of cases, they suffer from a sensitivity to
a consistent divergence in the performances of the
individual forecasts, as is demonstrated by the poor
performance for one of the four datasets.
4.3.2. Probabilistic forecasts
Although the literature on the combination of point
forecasts is very rich, the topic of combining probabilis-
tic (i.e., interval and density) forecasts is not so pop-
ular. Moreover, to the best of our knowledge, prior to
three very recent papers, there had not been a sin-
gle publication on the combination of interval or den-
sity forecasts in EPF. Nowotarski and Weron (2014a)
examine possible accuracy gains from forecast averag-
ing in the context of interval forecasts. They propose
a new method for constructing PIs dubbed Quan-
tile Regression Averaging (QRA; Matlab code is available
from http://ideas.repec.org/s/wuu/hscode.html) which
utilizes the concept of quantile regression (QR; see e.g.
Koenker, 2005) and a pool of point forecasts of individual
(i.e., not combined) time series models. Using the condi-
tional coverage test of Christoffersen(1998), they reachthe
conclusion that, while the empirical PIs (see Section 4.2.1)
from combined forecasts do not provide significant gains
for the PJM dataset considered, the QRA-based PIs are
found to be more accurate than those of the best individ-
ual (SNAR) and benchmark (AR) models. In a follow-up
paper, Nowotarski and Weron (2014b) consider a differ-
ent calibration scheme and a more spiky (in the out-of-
sample test period) Nord Pool dataset, and again confirm
the superiority of the QRA-based PIs. Maciejowska et al.
(2014) further extend the QRA approach and use princi-
pal component analysis to automate the selection process
from among a large set of individual forecasting models
available for averaging. In terms of unconditional coverage,
conditional coverage and the Winkler score, the resulting
Factor QRA (or FQRA) approach performs significantly bet-
ter than the benchmark ARX model and moderately better
than QRA (for data from the British power market over the
period 1.7.2010-31.12.2012).
In the general forecasting context, there have been very
fewpapers that have dealt explicitly with the combination
of interval forecasts (note that the latter can be obtained
as the quantiles of density forecasts). Luckily, there has
been some progress in the area of density forecasts
in the last decade, which will hopefully infiltrate the
EPF literature in the coming years. For instance, Wallis
(2005) proposes a finite mixture distribution as an
appropriate statistical model for a combined density
forecast, then discusses its implications for combining
interval forecasts. Hall and Mitchell (2007) propose a
data-driven approach to the direct combination of density
forecasts by taking a weighted linear combination of the
competing density forecasts. The combination weights
are chosen to minimize the distance, as measured by
the KullbackLeibler information criterion, between the
predicted and true but unknown density. Mitchell and
Wallis (2011) review current density forecast evaluation
procedures and introduce a new test of density forecast
efficiency. Kociecki, Kolasa, and Rubaszek (2012) introduce
a formal method of combining expert and model density
forecasts when the sample of past forecasts is unavailable.
Finally, Billio, Casarin, Ravazzolo, and Van Dijk (2013)
propose a Bayesian combination approach for multivariate
predictive densities which relies upon a distributional
state space representation of the combination weights.
4.4. Multivariate factor models
As was discussed in Sections 3.63.9, the literature
on forecasting daily electricity prices has concentrated
largely on models that use only information at the
aggregated (i.e., daily) level. On the other hand, the
very rich body of literature on forecasting intra-day
prices has used disaggregated data (i.e., hourly or half-
hourly), but generally has not explored the complex
dependence structure of the multivariate price series. A
notable exception is a working paper from1997, published
by Wolak (2000), in which principal component analysis
(PCA) is applied to hourly or half-hourly prices from the
UK, Scandinavia, Australia and New Zealand, in order to
gain an understanding of the price formation mechanism
and measure the relative predictability of the daily vector
of prices in each country.
A decade passed before the multivariate context of
spot electricity prices was picked up again by Huisman
et al. (2007) and Panagiotelis and Smith (2008). In the first
paper, hourly data from The Netherlands, Germany and
France are expressedinthe formof a panel, and the authors
use seemingly unrelated regressions (SUR); they find that
the prices in peak and off-peak hours are correlated highly
among each other, but that there is much less correlation
between the two groups. In the second, a first order vector
autoregressive model with exogenous effects and skew t
distributed innovations is used, and the authors uncover
strong diurnal variation in many of the parameters.
The vector autoregressive (VAR) structure is a good
starting point for multivariate factor models; for an
excellent introduction to multivariate time series models,
see Ltkepohl (2005). Let us first represent the hourly
(half-hourly load periods can be considered analogously)
spot price as a set of 24 univariate AR processes:
P
kt
=
k
D
t
+
q
i=1
ik
P
k,ti
+
kt
, (24)
where k = 1, . . . , 24,
k
is a vector of parameters, and
D
t
is a vector of exogenous, deterministic variables. This
can be interpreted as a restricted VAR(q) model, with
diagonal parameter matrices B
i
and uncorrelated residuals
t
, i.e., P
t
= AD
t
+
q
i=1
B
i
P
ti
+
t
, where P
t
= [P
1t
,
. . . , P
24t
]
,
t
= [
1t
, . . . ,
24t
]
, A is a vector of deter-
ministic parameters and B
i
are 24 24 matrices of
autoregressive parameters. The restricted VAR model uses
information about hourly prices, but does not explore the
intra-day correlation structure. Since all hours during the
day are correlated with each other, or at least within the
peak and off-peak hours (Huisman et al., 2007), it seems
reasonable to model themjointly. However, if we do so, the
large number of parameters needing estimation (1 + 24q
in each equation) may result in over-fitting, yielding small
in-sample residuals but large out-of-sample errors.
If we want to explore the structure of intra-day elec-
tricity prices, we need to use dimension reduction meth-
ods; for instance, factor models with factors estimated as
principal components (PC). PC estimation is consistent for
large dimensional models where both of the dimensions
time and the number of series tend to infinity (Bai,
2003; Bai & Ng, 2002; Stock & Watson, 2002). When con-
sidering hourly data for one location, the panel consists of
24 variables. However, when multiple locations are con-
sidered, like the 20 PJM locations studied by Maciejowska
and Weron (forthcoming), the panel should be sufficiently
large to approximate the true factors.
The main assumption of the factor models is that all
variables P
kt
, k = 1, . . . , 24, co-move, and depend on a
small set of common factors F
t
= [F
1t
, . . . , F
Nt
]
. The
individual series P
kt
can be modeled as a linear function of
N principal components F
t
and stochastic residuals
kt
:
P
kt
=
k
F
t
+
kt
, (25)
where the loads (or loadings)
k
= [
k1
, . . . ,
kN
] de-
scribe the relationshipbetweenthe factors F
t
andthe panel
variables P
kt
. Note that these loads are not power system
loads, but model parameters (as in Bai, 2003). The eigen-
vectors corresponding to the N largest eigenvalues of the
matrix P
P multiplied by

T are consistent estimators of
the common factors F
t
(see e.g. Stock &Watson, 2002). The
number of common factors can be chosen on the basis of
information criteria (like IC
2
and IC
3
, proposed by Bai & Ng,
2002) or the fraction of the total variability explained.
In order to be able to predict future values of P
kt
, we
need to forecast both the common factors F
nt
and the
idiosyncratic components
kt
. Although the factors are
contemporaneously orthogonal, they may still be inter-
temporally correlated, due to normalization assumptions.
Hence, it seems reasonable to model them jointly.
Moreover, they may depend on some other variables, such
as the deterministic variables (D
t
). At the same time, the
idiosyncratic components can only be correlated weakly
across periods, and can therefore be modeled separately
for each hour. Moreover, they cannot have the same
seasonal pattern, because all of the co-movement between
hours is captured by the factors. It is natural (see e.g.
Maciejowska & Weron, forthcoming) to assume that the
common factors follow a VAR(p) model:
F
t
= D
t
+
p
i=1
i
F
ti
+
t
, (26)
Fig. 15. Upper panel: PJMDominion Hub hourly (gray) and average daily (black) systemspot prices in the period 1.1.200831.12.2012. The vertical dotted
line represents the beginning of the two-year out-of-sample test period. Lower left panel: The loadings obtained for a three-factor model, see Eqs. (25)(26).
Lower right panel: The relative RMSE of average daily price forecasts with respect to the forecasts of the benchmark univariate AR model. Clearly, the factor
model (FM) outperforms the benchmark for all forecast horizons.
where denotes a N M matrix of deterministic
coefficients, M is the number of deterministic variables,
and
i
are N N matrices of autoregressive parameters.
To describe and forecast the idiosyncratic components
kt
,
we can use AR models, independently for each k.
To illustrate the gains from developing factor models,
let us consider the hourly electricity prices for the
Dominion Hub in the PJM power market (US) over the
period 1.1.200831.12.2013, see the upper panel of Fig. 15.
The first three years are used for calibration only (we
use a rolling calibration window), and the last two for
out-of-sample testing. Three models are evaluated: a
benchmark univariate AR(7) model, a restricted VAR(7)
model (see Eq. (24)), and a three-factor model (see Eq.
(25)), with the factors given by a VAR(7) model (see Eq.
(26)). The factor loadings obtained are depicted in the
lower left panel. The first loading may be interpreted as
the level with an afternoon peak profile, the second as
the morning peak, and the third as the mid-day peak.
The relative RMSEs of average daily price forecasts with
respect to the forecasts of the benchmark univariate AR
model, i.e., RMSE
i
/RMSE
AR
, are plotted in the lower right
panel for forecasting horizons of 1 to 60 days. Clearly,
the factor model (FM) outperforms the benchmark for all
forecast horizons. The difference is significant at the 5%
level (according to the Diebold & Mariano, 1995, test; see
Section 4.5.2) for horizons of four days or more. On the
other hand, the restricted VAR model is better than the
benchmark in the short-term, but worse in the mid-term.
In contrast to the relatively long history of using uni-
variate models for EPF (see Sections 3.63.9), applications
of multivariate models have appeared in the literature
only within the last six years. Chen, Deng, and Huo (2008)
use manifold learning (an extension of PCA) to remove
intra-day and intra-week seasonality from hourly elec-
tricity prices, and predict them using three techniques.
Their approach compares favorably to those of ARIMA, ARX
and nave methods in one day, one week and one month
ahead forecasting of hourly NYISOprices. Hrdle and Trck
(2010) use dynamic semiparametric factor models (DSFM)
for EPF of hourly electricity prices in the German EEX mar-
ket. They find that a model with three factors is able to ex-
plain up to 80% of the variation in hourly prices; however,
the explanatory power decreases significantly for periods
with higher numbers of price spikes.
Over the last two years, an increased inflow of mul-
tivariate EPF papers can be observed. In particular, Pea
(2012) analyzes hourly electricity prices in three day-
ahead markets using a periodic panel model, and finds
that, when all hourly prices are modeled jointly as a panel,
autoregressive periodic components models describe the
data better than standard non-periodic models. Garcia-
Martos et al. (2012) propose to extract common factors
from hourly prices and use them for one-day-ahead fore-
casting within a dynamic factor model (DFM) framework.
They also report some preliminary results showing the
usefulness of factor models for mid- and long-term pre-
dictions. Vilar, Cao, and Aneiros (2012) use a nonparamet-
ric regression technique with functional explanatory data
and a semi-functional partial linear (SFPL) model to fore-
cast hourly day-ahead prices in the Spanish market, and
find it to be superior to the ARIMA and nave approaches.
Elattar (2013) proposes to combine kernel PCA (for
extracting features of the inputs) with a Bayesian local
informative vector machine (for making the predictions),
and finds the resulting technique to be superior to 12
other methods, including ARIMA and ANN, for short-term
price forecasting in the Spanish market in 2002. Miranian,
Abdollahzade, and Hassani (2013) apply the singular
spectrumanalysis (SSA; whichis somewhat similar to PCA)
to obtain extremely accurate one-step-ahead predictions
of the hourly day-ahead prices in the Australian and
Spanish power markets. Their results are controversial,
however, as their method is roughly three times more
accurate than the competitors (ARIMA, MLP and RBF
networks), and is presumably able to predict irregularly
appearing price spikes almost perfectly for a test week
in January 2006, even in the extremely spiky Australian
market. Wu et al. (2013) propose an RDFA algorithm (see
Section 4.2.1) and showthat it outperforms functional PCA,
ARwith a time varying mean, and SVRmodels in predicting
hourly day-aheadprices inthe AustralianandNewEngland
markets.
There are also a few articles which exploit the idea of
using disaggregated data for the forecasting of aggregated
variables, an approach with roots in macroeconomet-
rics (Bermingham & DAgostino, 2014; Hendry & Hubrich,
2011). For instance, Liebl (2013) proposes the modelling
and prediction of electricity spot prices by first finding
the functional relationship between prices and demand in
terms of daily price-demand functions, then parametrizing
the series of daily price-demand functions using a func-
tional factor model. He demonstrates the power of this
approachby comparing aggregateddaily price forecasts for
1 to 20 days ahead from the model with those from two
simple univariate time series models for daily prices (AR
and MRS) and two alternative functional data models for
hourly prices (DSFM and SFPL). Maciejowska and Weron
(2013) use half-hourly data from the UK power market to
forecast the average daily spot prices bothdirectly (via ARX
and vector ARX models) and indirectly (via factor models).
The results indicate that there are forecast improvements
from incorporating disaggregated (i.e., hourly) data, espe-
cially when the forecast horizon exceeds one week. Ra-
viv et al. (2013) exploit the information embedded in the
cross correlationof NordPool hourly price series inorder to
obtain more accurate one-step-ahead average daily price
forecasts for Scandinavia. Finally, Maciejowska and Weron
(forthcoming) evaluate the forecasting performances of
four multivariate models (a restricted VAR and three fac-
tor models) calibrated to hourly and/or zonal day-ahead
prices in the PJM market, and compare them with that of
a univariate AR model, which uses only average daily data
for the PJM Dominion Hub. The results indicate that there
are forecast improvements from incorporating the addi-
tional information, essentially for all forecast horizons con-
sidered, from one day to two months, but only when the
correlation structure of prices across locations and hours
is modeled using factor models.
As the literature review in this section suggests, there
is definitely potential in using the multivariate modeling
approach. With the increase of computational power, the
real-time calibration of these complex models will become
feasible (Chan et al., 2012). We expect to see more EPF
applications of the multivariate framework in the coming
years.
4.5. The need for an EPF-competition
All major review publications (see Section 2.2) have
concluded that there are problems with comparing the
methods developed and used in the EPF literature. This
is due mainly to the use of different datasets, different
software implementations of the forecasting models and
different error measures, but also to the lack of statistical
rigor in many studies.
As a result, many of the published results seem to con-
tradict each other. For instance, Misiorek et al. (2006) re-
port a very poor forecasting performance of a MRS model,
while Kosater and Mosler (2006) reach the opposite con-
clusion for a similar MRS model but a different market and
mid-termforecasting horizons. On the other hand, Heydari
and Siddiqui (2010) find that a regime-switching model
does not capture price behaviors correctly in the mid-term.
The cross-category comparisons are even less conclusive
and more biased. Typically, advanced statistical techniques
are compared with simple CI methods (see e.g. Conejo,
Contreras et al., 2005), and vice versa (see e.g. Amjady,
2006). However, our impression is that sophisticated, fine-
tuned representatives of the two groups should be com-
petitive if on equal terms. Moreover, at least at this stage, it
seems unlikely that there exists any one model that would
systematically outperform other models on a consistent
basis.
4.5.1. A universal test ground
All of this calls for a comprehensive, thorough study
involving (i) the same datasets, (ii) the same robust
error evaluation procedures, and (iii) statistical testing
of the significance of one models outperformance of
another. The time has come for an M-Competition in
EPF.
4
The major advantage of such a comprehensive
forecasting competition is that it assures objectivity, while
guaranteeing expert knowledge.
We agree with Aggarwal et al. (2009b) that the
forecasting test periods used in most EPF studies are too
short to yield conclusive results. Test samples of carefully
selected one-week periods, even if taken from different
seasons of the year, generally ignore the problem of
special days (holidays, near-holidays). Only longer test
samples of several months to over a year should be
considered. Moreover, while the number of test series
considered in the most recent M-Competition (i.e., 3003)
is by far too large for an EPF-Competition, there should be
sufficient data available to enable such a competition to be
conducted, given that electricity markets have existed for
over a decade in many countries now.
Some power exchanges and data vendors openly
provide high-frequency (hourly, half-hourly) time series
of electricity prices on their web pages. For instance,
Nord Pool publishes price and other fundamental power
market data for the most recent two-year period;
5
Elexon, the British market operator, publishes all kinds
of balancing market data (including reserve margin
forecasts);
6
electricity prices for the UKcanbe downloaded
from the APX power exchange website;
7
and GDF Suez
4
The Makridakis or M-Competitions were empirical studies that
compared the performances of large numbers of major time series
methods using recognized experts who provided the forecasts for their
own method of expertise; see Makridakis and Hibon (2000) for a
discussion of the results.
5
See www.nordpoolspot.com/Market-data1/Downloads/Historical-
Data-Download1/Data-Download-Page.
6
See www.bmreports.com.
7
See www.apxgroup.com/market-results/apx-power-uk/ukpx-rpd-
historical-data.
provides hourly prices for five US markets, including the
worlds largest power market the Pennsylvania-New
Jersey-Maryland Interconnection (PJM).
8
Perhaps some of
these entities would be interested in participating in an
EPF-competition and maintaining a database of electricity
market time series which could form a universal testing
ground for all EPF experts.
Finally, let us note that since submitting the first version
of this article to IJF, we have learned that GEFCom2014 (see
www.gefcom.org) will include a track on electricity price
forecasting! The Global Energy Forecasting Competition
is an initiative of the IEEE Working Group on Energy
Forecasting. The first event, GEFCom2012, included only
two tracks load and wind power forecasting but
attractedmore than200teams whichsubmittedmore than
two thousand entries (Hong, Pinson, & Fan, 2014). The
second competition, to be launched on 15 August 2014,
will probably attract even more participants. Hopefully,
the organizers will take into account some of the
suggestions put forward in this article.
4.5.2. Guidelines for evaluating forecasts
Error measures for point forecasts were discussed in
Section 3.3. A selection of the better-performing measures
(weighted-MAE, seasonal MASE or RMSSE) should be used
either exclusively or in conjunction with the more popular
ones (MAPE, RMSE). One issue inrelationto error measures
that has apparently been downplayed in the EPF literature
is that of statistical testing for the significance of the
differences in forecasting accuracies of the models. In
econometrics, the most popular approach is the Diebold
and Mariano (1995) test; see Diebold (2013) for a recent
discussion of its uses and abuses. The DM test is simply
an asymptotic z-test of the hypothesis that the mean of
the loss differential series, i.e., d
t
= L(
1,t
) L(
2,t
),
is zero. In applications, L(
i,t
) is typically taken to be
the absolute |
i,t
| or square
2
i,t
loss, and
i,t
= X
t

X
i,t
is the forecast error for model i = 1, 2. The test statistic
is then calculated as: DM =

d/
d
, where

d is the sample
mean of the loss differential and
d
is a consistent
estimate of the standard deviation. Since forecast errors,
and hence loss differentials, may be serially correlated,

d
has to be calculated robustly. The DM test statistic
is N(0,1)-distributed, and one- or two-sided tests can be
constructed easily. Nowadays, many statistical computing
environments, like Matlab or R, include the DM test in the
standard releases or as an add-in.
Alternative forecast comparison test procedures in-
clude the model confidence set approach of Hansen, Lunde,
and Nason (2011), which is similar to the DM test for two
models but estimates the distribution of the test statis-
tic using a bootstrap procedure, and a test of forecast en-
compassing, whose null hypothesis is that the predictions
from model 1 do not contain additional information rel-
ative to those of model 2 (if this is the case, we say that
model 2 encompasses model 1; see Harvey, Leybourne, &
Newbold, 1998). In one of the few applications in EPF, Bor-
dignon et al. (2013) perform all three tests for evaluating
8
See http://www.gdfsuezenergyresources.com/index.php?id=712.
combined point forecasts, see Section 4.3. Moreover, Cruz
et al. (2011); Cuaresma et al. (2004); Diongue et al. (2009);
Gianfreda and Grossi (2012); Hong and Wu (2012); Ma-
ciejowska and Weron (forthcoming) and Nowotarski et al.
(2014) perform the DM test.
Evaluating interval and density forecasts is more tricky.
While there are numerous methods for calculating interval
forecasts, only a few studies have proposed appropriate
validation methods. One of the main exceptions is the
seminal paper of Christoffersen (1998), which develops
a model-independent approach based on the concept of
PI violations. Three tests are carried out in the likelihood
ratio (LR) framework, for the unconditional coverage,
independence and conditional coverage. The LR statistics
corresponding to the former two tests are distributed
asymptotically as
2
(1), and those corresponding to the
the latter as
2
(2). Moreover, if we condition on the
first observation, then the conditional coverage LR test
statistic is the sum of the other two (Matlab code is
available from http://ideas.repec.org/s/wuu/hscode.html).
The unconditional coverage test compares the nominal
coverages of the models to the true coverage, and is also
knowninthe risk management (Value-at-Risk backtesting)
literature as the Kupiec (1995) test. The independence
test checks that the PI violations do not cluster. Finally,
the conditional coverage test is a combination of the two.
Christoffersens tests have been applied by Maciejowska
et al. (2014), Nowotarski and Weron (2014a,b), Sharma
and Srinivasan (2013) and Weron and Misiorek (2008)
for evaluating electricity spot price PIs, and by Chan
and Gray (2006) and Cifter (2013) in the context of
computing the Value-at-Risk for daily electricity spot
prices, i.e., PIs for spot price returns. It should be noted
that the independence test and hence the conditional
coverage test are typically conducted only with respect to
the first order dependency of exceedances. However, as
Clements and Taylor (2003) show, the test can be easily
modified to measure higher order dependency; see e.g.
Maciejowska et al. (2014) for a sample application of this
approach in the context of EPF. Berkowitz, Christoffersen,
and Pelletier (2011) go one step further and using the
LjungBox statistic jointly test for independence inthe first
m lags.
Wallis (2003) recasts Christoffersens tests in the
framework of
2
statistics, and considers their extension
to density forecasts. The use of the contingency tables
framework increases these methods accessibility to users,
and allows the incorporation of a more informative
decomposition of the
2
goodness-of-fit statistic and
the calculation of exact small-sample distributions. More
recently, Dumitrescu, Hurlin, and Madkour (2013) propose
a generalized method of moments (GMM) approach for
testing PIs using discrete polynomials. The series of PI
violations is split intoblocks of size N. The sumof violations
within each block follows a binomial distribution, and
the proposed approach involves testing that the series of
sums is indeed an i.i.d. sequence of random variables that
are binomially distributed. Candelon, Colletaz, Hurlin, and
Tokpavi (2011) use a similar approach in the context of
Value-at-Risk backtesting. See also Berkowitz et al. (2011)
for a review of autocorrelation-based, duration-based and
spectral density-based tests for clustering of Value-at-Risk
exceedances.
Regarding density forecasts, a good starting point is
the comprehensive review of Tay and Wallis (2000);
see also Wallis (2003), who proposes
2
tests for
both intervals and densities, and Berkowitz (2001), who
suggests an approach to the evaluation of density forecasts
that is now popular in the Value-at-Risk backtesting
literature. Finally, Bao et al. (2007) compare various
density forecasting models using the KullbackLeibler
Information Criterion (KLIC) of a candidate density forecast
model with respect to the true density, and discuss how
this KLIC is related to the KLIC based on the probability
integral transform (PIT) in the framework of Diebold
et al. (1998). They find that the two approaches are
asymptotically equivalent, but that the PIT-based KLIC
is better for evaluating the adequacy of each density
forecasting model and the original KLIC is better for
comparing competing models.
4.6. Final word
We hope that the methods, problems and suggestions
discussed in this section and in the article as a whole will
encourage researchers working in the area of electricity
price forecasting to develop more efficient and better-
grounded models and techniques. We also hope that this
review will provide an impetus for those working in other
areas of forecasting to move into the exciting, unique, and
largely unexplored world of wholesale electricity markets.
Acknowledgments
This paper has benefited from conversations with the
participants at the Conferences onEnergy Finance (EF2012,
EF2013), the European Energy Market (EEM12, EEM14)
Conferences, the Energy Finance Christmas Workshops
(EFC12, EFC13), and the seminars at Macquarie University,
National University of Singapore (NUS), Norwegian Uni-
versity of Science and Technology (NTNU), University of
Sydney, University of Verona and Wrocaw University of
Technology. Critical comments and suggestions from Tao
Hong, Rob Hyndman, Pierre Pinson and two anonymous
referees are gratefully acknowledged. Special thanks for
feedback on earlier versions of the manuscript and com-
putational assistance go to Katarzyna Maciejowska, Pawe-
Maryniak and Jakub Nowotarski. This work was supported
by funds from the National Science Centre (NCN, Poland)
through grant no. 2011/01/B/HS4/01077.
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is the long term

= 40, = 0.2 and = 6, Gaussian spikes with =

+ 100 and = 30, and the transition matrix defined by p

. They differ in the type of dependence between

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